A private equity fund can use the money it receives from its investors for several purposes, including buying real estate and providing venture capital to new companies, according to Ohio State University. A buyout fund specializes in purchasing existing companies, whether the company's management is willing to sell the company or the fund has to perform a hostile takeover.
To gather the cash to purchase a large company, several buyout funds may work with one another. According to the Wharton School of Business, buyout funds working together have planned to purchase the stock of companies with valuations of more than $100 billion.
A buyout fund normally arranges its business structure as a limited partnership. These limited partnerships are usually time limited, according to New York University. This structure protects the private equity investors. Each private equity investor is only liable for his investment into the buyout fund, and the general partner decides which companies the fund purchases.
A buyout fund usually does not have enough cash to buy all of the shares of the target company. The buyout fund can borrow money from a bank to perform the takeover, and the limited liability of each private investor protects him, making it safer for the fund to operate using financial leverage.
A buyout fund is a closed fund, so it can not ask its equity investors to give it more cash to perform buyouts after it is set up, according to New York University. If the buyout fund can profitably invest in other companies, but it does not have enough cash available and banks will not offer it more leverage, the fund's managers can set up a second buyout fund, although it may take months to organize the second fund.
Investing in a buyout fund can be riskier for an individual investor than purchasing the shares of the target company. If the investor buys shares of the target company in the stock market, she can decide to sell them if she changes her mind about purchasing the company. If the general partner purchases stock in a company and an individual investor believes this is a bad decision, it is more difficult for her to sell her share in the buyout fund.
- New York University; The Investment Behavior of Buyout Funds: Theory and Evidence; Alexander Ljungqvist, et al.; June 2007
- Ohio State University; Why Are Buyouts Levered? The Financial Structure of Private Equity Firms; Ulf Axelson, et al.; 2007
- Wharton School of Business: Following the Era of Large Buyouts, Private Equity Firms Find New Ways to Compete