PRIVATE EQUITY (ISSUANCE PROCESS)

 

Private equity is a different type of private financing that takes place outside of the public markets and involves funds and investors directly investing in businesses or buying them out. By charging management and performance fees to fund investors, private equity companies generate revenue. Private equity has benefits such as quick access to alternative types of finance for business owners and founders and less stress from quarterly results. The fact that private equity valuations are not determined by market forces offsets these benefits. Other than that, institutional and accredited investors, who have the financial wherewithal to commit substantial quantities of money over protracted periods of time, are the main sources of private equity investment. Private equity investments typically demand very long holding periods in order to guarantee a turnaround for troubled firms or to facilitate liquidity events like an initial public offering (IPO) or a sale to a public company.

Companies and start-ups can benefit from private equity in a number of ways. Companies choose it because it gives them access to cash as a substitute for traditional financial processes like high interest bank loans or going public. Venture capital is one type of private equity that finances start-up businesses and innovative concepts. Private equity funding can assist delisted firms in attempting unconventional development plans away from the scrutiny of public markets. Otherwise, senior management's timeframe for turning around a firm or experimenting with new ways to decrease losses or create money is drastically reduced by the pressure of quarterly profits.

However, private equity still has its own challenges and disadvantages. Firstly, because there is no ready-made order book that connects buyers and sellers like there is in public markets, it can be challenging to sell stakes in private equity. Secondly, unlike publicly traded corporations, where share prices are often set by market forces, private equity companies' share prices are decided through discussions between buyers and sellers. Thirdly, unlike the broad governance framework that often determines the rights of their counterparts in public markets, the rights of private equity shareholders are frequently negotiated on a case-by-case basis. 

    In the issuing process, there are several steps that need to be followed such as:

PRIVATE EQUITY FIRM FUNDRAISING

        Private equity fundraising describes the process through which private equity businesses look to raise money from investors. Instead of becoming an investor in the company itself, a typical investor will make an investment in a particular fund that is managed by the company. Because of this, an investor will only profit from investments made by a company if those investments are made from the same fund that the investor has invested in. The length of time it takes a private equity business to raise money depends on the level of investor interest, which is determined by the state of the market as well as the success rate of prior funds raised by the firm in question. When companies are able to raise money quickly and easily, it’s often by securing commitments from investors in prior funds or when good historical performance generates high levels of investor interest, they can spend as little as one or two months on the capital raising process.

      Musharakah paired with wakalah, whereby the fund enters into an informal partnership arrangement with the business and also hires the firm as its agent to deploy its capital in various activities, is the optimum form for Islamic private equity funds investing into private equity firms. The conditions of the connection might vary, but one of the finest guides has been offered by the Institutional Limited Partners' Association's Private Equity Principles, which emphasize alignment of interest, transparency, and good governance as the three most crucial tenets. The private equity company serving as the general partner would frequently add at least 1% capital to the portfolio of investees to promote alignment of interest.

DEAL GENERATION

        A key idea in private equity funding is deal generation. According to some private equity, it serves as the most crucial role in the private equity investment process. For a private equity company, greater profits are virtually always produced by a robust pipeline of high-quality investments. Deal generation, also known as deal flow, refers to the capacity of a private equity company to provide a steady supply of investment possibilities.

        Any private equity firm's business strategy depends on its capacity to generate a significant amount of deal flow. The most successful businesses have access to networks that give them first rights on any potential investee, since businesses and corporations looking for capital favour those enterprises with a track record of effectively producing value and launching and exiting investments. Informal industry relationships and peers are crucial, in addition to more formal sources like investment bankers and other professional consultants. Smaller businesses may be forced to use internet marketing tools to promote their products.

INITIAL SCREENING

       The private equity company might analyse the proposal's potential ‘fit’ through an initial screening. The company plan and the general industry perspective, particularly with regard to the potential for expansion on a national, regional, and worldwide scale, would be the main areas of attention at this point. Additionally, there is a preliminary analysis of the market's structure (fragmented or consolidated), segmentation, profitability over the long term, and entry hurdles. The main goal at this point is to weed out the unrealistic plans so that time, effort, and money are not wasted later on. The initial evaluation would include the company's industry position, its competitive advantage, market share, financial performance, and capital structure for buy-out, expansion, development, or even turn-around funds. Shariah sectoral and financial screening must be done at this point as well to assure suitability.

DUE DILIGENCE AND VALUATION

        The process of investing in private equity must include due diligence. Possible investors "look beneath the hood" during this phase by gathering data to investigate and validate management's financial and operational numbers while assessing a potential investment. To make the best investment decision, it is important to identify and reduce any potential risks. This step of the procedure is critical since it is at this point that private equity investors and their teams (consultants, accountants, lawyers, etc.) assess and identify any significant red flags like financial liabilities, operational, legal, and other types of risks. Due diligence has particular difficulties in the private equity industry. As example, the majority of private equity firms concentrate on buying private businesses with little accessible information, lacking SEC filings and other public sources. The proposal must pass each of the prior checkpoints before it can go on to valuation. The firm must be valued at the time of purchase since smart purchasing is one of the key components of a successful private equity transaction.

STRUCTURING

        Next step for Islamic equity process is structuring. It is required to discuss and structure the transaction with the investee once the proposal has been authorised for investment. The scope of investment, including fund disbursement stages, investor protections required, degree of involvement, management interests and incentives, and perceived exit should all be considered.

        Within the Islamic perspective, the Islamic banks would use the same criteria, in analysing ventures to invest in, namely the entrepreneur's aptitude and the project's profit potential. This is why, as an Islamic transaction, murabahah (cost plus financing) is deemed less risky than mudarabah (profit-sharing) and musharakah (partnership). The aspect of profit and loss sharing should be present in any real Islamic financing or investment structure.

        Firstly, is the Mudarabah contract (profit sharing). Mudarabah contract is one of the typical forms of Islamic private equity. It is basically a contract made between two parties involved to finance a business venture. The parties are investors (rabbul mal) the one who solely provides the capital or funds, while the entrepreneur (mudarib) the one who invest their energy and effort to the business venture. For profit, the profit will be distributed based on a pre-agreed ratio between the investor and the entrepreneur. But, if the business faces losses, the losses will be borne solely by the investors only, this is because the entrepreneur is facing losses in his effort and time.

        Next is the Musharakah contract. The Musharakah contract is a partnership between two or more parties to give capital or funds to the business. The profits are shared between the members according to a pre-agreed ratio, as well as the losses, it must be shared between the members on the basis of capital contribution.

      Lastly is wakalah. Wakalah contract is basically a contract in which a person with full legal capacity permits another to enter into a specific, well-defined permissible contract on his or her behalf (agent). For Isamic private equity, the wakalah contract gives the agent the authority and rights to act on behalf of the principal for as long as the principal is alive.

POST-INVESTMENT MONITORING

            Once the private equity firm takes an equity stake in the business, whether minority or majority, it will expect and be entitled to a position on the board of directors. An investor has a variety of possibilities for involvement and duties after investing. While more active investors may develop a major representation on the board of directors, passive investors may just want to receive reports outlining the management's performance.

Financial and social data reporting, whether passive or active, is typically the first important item after the investment is made. A passive impact investor will want to see the company's success and the creation of social benefit. While actively seeking signs of issues, an active investor shares the same desire to comprehend the current situation and most recent successes of the company. Beyond the first investment, seasoned active investors are able to identify problems before they escalate into serious problems that could cripple a company.

            An investor might focus their efforts after setting up a dependable and informative reporting system. Additionally, the investor must collaborate with the business to determine how best to leverage their skills and experience to advance their social and financial mission. Impact investors typically have the special expertise needed to help the firm retain and enhance its social goal as it grows.

 EXIT

            A properly planned (financially feasible and Shariah-compliant) exit strategy is required after investors have evaluated the company and invested. There are several options available to IVC investors and management of the invested company to execute “exit” transactions. These alternatives include IPO, leveraged buyouts (LBOs), management buyouts (MBO), mergers and acquisitions (M&As), systematic liquidation and a newly innovated Shariʿah-compliant method known as musharakah mutanaqiṣah (MM; diminishing partnership).           

            In an Islamic private equity investment, if the anticipated exit is by way of a sell-down or buy-back by the original owners or management, the sale price must be calculated at enterprise value at the time of sale.