Private equity investing firms are typically privately-owned companies that invest money in small and medium-sized businesses. Private equity is generally used to describe a group of investment firms that have a broad range of financial backgrounds and can purchase and dispose of companies at will. The following are major types of private equity.
Venture Capital
Private equity firms are investment firms that pool money from high-net-worth individuals, pension funds, and other institutional investors. A venture capital firm is a private equity firm that invests in early-stage, technology-based companies. According to veterans like Peter Comisar, the common characteristics of these investments are an emphasis on technology within the company, a focus on identifying and developing potential growth areas, and the capability to be highly successful and play a long-term role in the company.
Leveraged Buyout (LBO)
In a leveraged recapitalization, a private equity firm buys all or part of a company’s stock on the open market, then uses an aggressive refinancing to pay down all or part of that purchase price over time. In this type of investment, private equity investors take control of a company by purchasing some or all of its outstanding shares. The result is that the company’s shareholders own a smaller amount of the company. The management team is usually replaced. In addition, the private equity firm itself adds a layer of middle management between the original owners and the operating business.
Distressed Investments
A distressed investing firm typically involves purchasing a company in financial distress. These deals are executed rapidly and usually require the replacement of at least a portion of the target’s senior management. The intent is to capitalize on events or decisions by command or by market changes that have resulted in a sharp decrease in the target’s stock value. As a result, this creates an opportunity to purchase assets for less than their replacement cost.
Growth Capital Investments
Growth capital investments come in two main forms, expected return (ERI) and return-to-investment (RTO). Both ERI and RTO return to investors from appreciation on an investment after exiting through either sale or IPO. With ERI, growth capital investors can expect a return that covers their original capital investment and an additional amount of return on their investment once they exit their investment through either sale or IPO. With RTO, growth capital investors can expect to get their original invested capital back when they exit.
Mezzanine Finance
Mezzanine financing aims to obtain a larger ownership share in a company at a lower price than would be anticipated in an LBO. Mezzanine loans are typically provided by a bank acting as the lender rather than a private equity firm acting as the majority shareholder. Mezzanine debt is usually priced at a fixed rate and may be secured or unsecured. When public equity markets drop, the demand for private equity firms increases as an alternative source of financing.
Private equity firms combine individual pieces of a company’s assets into one whole. This allows them to make changes as needed, such as shutting down a part of the company if it is not working out or combining or separating pieces of the whole. They also look at what each part of the company stands for in its potential future success. This includes how big it can get or how much it contributes to its bottom line at present.
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