Equity development investment refers to private equity funds taking controlling stakes in companies and actively engaging in their operations and strategy to improve performance. As an alternative investment strategy, private equity firms raise pools of capital from institutional investors like pension funds and use that capital to invest in private companies, with the goal of eventually selling them for a profit. While stock market investors generally take a passive role, private equity firms take an active role in running the companies they invest in. By bringing in specialized expertise and focusing intently on improving operations, private equity funds aim to significantly increase the value of their portfolio companies over a 3-5 year investment horizon. This hands-on involvement in developing companies is how private equity generates superior returns compared to public market investing.
Private equity funds take controlling ownership stakes
Unlike public stock investors who typically own small fractions of companies, private equity funds often take controlling majority stakes or significant minority stakes in their portfolio companies. This gives them power to directly influence decisions like hiring/firing management, cutting costs, expanding into new markets, making acquisitions, changing strategic direction, and more. While public companies have responsibilities to a broad base of passive shareholders, private equity owned companies can focus intently on value creation.
Operating expertise to improve portfolio companies
Private equity firms employ professionals with operating experience as executives, consultants, and industry experts. They conduct intensive due diligence to identify operational inefficiencies and opportunities for improvement. After acquiring companies, they install oversight mechanisms like Boards of Directors to monitor performance. By advising management teams and transferring best practices between portfolio companies, private equity owners drive major changes that enhance productivity, lower expenses, and accelerate growth.
Incentive structures align interests
Private equity funds implement powerful incentive systems to align interests between themselves, management teams, and employees. Management teams are given equity stakes that pay off handsomely if companies perform well under private equity ownership. Profit-sharing bonuses and stock option plans also incentivize employees to work hard toward value creation goals. Because private equity funds own companies directly rather than through public stocks, they can design very focused incentive programs.
Ability to undertake major changes
Unlike public companies which face pressures to deliver smooth quarterly earnings, private equity funds have more flexibility to undertake major turnarounds, restructurings, new initiatives, capital investments, and other transformative actions aimed at boosting long-term value. Being private frees management teams to focus on operations rather than stock prices and make bold moves that may depress short-term earnings but create substantial value over the long run.
In summary, private equity funds generate returns for investors by taking control of companies and developing them through hands-on operational improvements, strategic changes, financial engineering, and incentive alignment. Their active involvement in directing companies contrasts sharply with the passive role of most stock market investors.