Private equity funds can bring about positive change in your company — whether that’s helping you grow, finance an acquisition or reorganize.
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What is private equity?
Private equity (PE) is finance provided to businesses — in return for an equity stake. These businesses are not traded on the stock market — and so shares cannot be bought publicly.
Private equity firms are investment management companies, that source capital and provide these private equity funds — to worthy businesses.
Common PE investment strategies include — executing leveraged buyouts, providing venture capital (VC) and investing growth capital.
Private equity provides an alternative way for companies to source funds — other than through conventional banks. It is considered an alternative asset class.
Private equity — considerations
Private equity investments can be made by private equity firms, venture capitalists or angel investors. Each class of investor — will have its own aims and investment strategies. However, they all fundamentally provide businesses with the working capital needed — to expand, develop new products and services, bolster balance sheets or restructure company operations.
In contrast to venture capital firms, private equity firms mostly invest in more mature companies — that generate revenue, have cash flow and are able to service debt. Having said this, PE firms also invest in underperforming companies — with the goal of restructuring them back to profitability.
Private equity firms source their funds from a number of different channels, particularly institutional investors like — insurance companies, endowments, pensions funds and high net worth individuals. These funds are then deployed and invested into companies that have the potential to grow, and be profitable. As well as sourcing funds from investors — private equity firms may also borrow money to finance their acquisitions (leverage).
The returns, that private equity firms see, come via company growth, operational improvements and/or financial restructuring. In addition, the experience and leadership that private equity managers bring to a company — is also important.
How does private equity work?
Private equity firms have a number of different investment strategies — including venture capital, growth capital, leveraged buyouts and distressed investments. Only some of these will be applicable to your business needs.
Once you know what particular type of PE investment you need — the best way to get connected is through a warm introduction. Family, friends and your network of contacts are the first places to look for someone — that can refer you to an appropriate private equity firm. As competition for PE funds is fierce — this is the best way to stand out from the pack.
Having said this, it is still possible to get PE finance without knowing someone, but this involves doing extensive research into PE firms — in order to find the one that best fits your business.
Any potential PE investment — will consist of three basic strategies:
- Buy: capital is sourced to complete the deal
- Change: purchased company grows, or is simply restructured — to enhance profitability
- Sell: private equity stake in the company — is sold for a profit.
Types of private equity funds
Private equity firms may invest in startups or emerging companies — in return for a relatively small stake in the business. This is more often known as venture capital. Here, investment funds are given to businesses that will grow rapidly — allowing a PE firm to profit from selling its stake in the company.
With growth capital, PE firms invest in more mature businesses. Companies eligible for this form of investment, will have proven business models — and will usually be looking to scale operations or enter new markets. These funds can be invested more broadly than VC capital (where money is reserved only for companies that can grow very rapidly).
With a typical leveraged-buyout transaction, a private equity firm will acquire majority control of an established company — using a significant amount of borrowed money (leverage). Here PE firms expect to generate returns, that outweigh any interest paid on the debt — and profitably exit the company in the future.
Private equity real estate, involves PE firms pooling together investor capital — to invest in residential and commercial properties. PE funds are an important source of property finance — particularly for larger more ambitious real estate projects.
Mezzanine finance consists of both debt and equity finance, and can be used to fund a company’s growth. Here companies take on debt capital, that gives the lender the right to convert that debt, into an equity stake in the company — if the loan is not repaid as per the initial agreement.
Here PE funds are invested in target companies — that need restructuring, turnaround or are in any other unusual/distressed situation. PE firms seek to profit from a change in the company’s valuation — as a result of that special situation. Examples include bankruptcy proceedings and company divestments.
Benefits of private equity
- Can raise big amounts of money
- Equity finance — generally no debt obligations
- PE firms normally have vested interest in your company’s success
- PE firms have the expertise and the right connections
Limitations of private equity
- Dilution — loose some control in your business
- May not be eligible — PE firms only invest in particular types of businesses
- Can take a while before cash is released
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