Private equity is not without controversy despite its many benefits. Critics highlight job cuts, excessive borrowing, and an emphasis on short-term gain.
Private equity is the use of assets by institutional and private buyers to purchase or invest in public companies. These funds are usually used for corporate growth or to improve an organization’s balance sheet. Private equity results from high-net-worth individuals and corporations that buy private sector stocks or acquire public companies to convert them into private equity and eventually divest from public bonds. Private equity is dominated by large institutional creditors such as mutual fund companies and smaller private equity funds funded by approved investment companies. This article examines the Private equity strategies in detail and how they work.
Private Equity Investment Strategies
Private equity investment strategies are most commonly:
1. Venture Capital
Venture capital is a private equity branch focusing on high-risk and start-up businesses. We associate these start-ups with young Silicon Valley-based technology companies. However, they can be in any industry. Most large food conglomerates now have a VC branch that invests in new food start-ups to capture recent trends.
Most of these start-ups will have the following characteristics.
- · New product or service with a claim of competitive advantage
- · Different business models
- · Fast revenue growth (but running losses often)
- · High debt levels fund initial expansions
Venture Capital is at the forefront of the private equity industry, and a vast infrastructure has been put in place to find young companies that have the potential to disrupt the market. In 2020, global VC investment was 300B – a staggering amount given that the world is undergoing a pandemic.
This figure includes all the different phases of Venture Capital, which are:
- · Seed Stage: These businesses are often just MVPs (minimum viable products) and need funding to advance to commercial viability. Most of the time, the VC
- investors take a negligible risk, but they can still reap the rewards if their business succeeds.
- · Early Stage: Companies in the early stages are operating commercially. Investors are looking for double-digit growth in revenue and perhaps users or customers to indicate that the company is worth investing their capital in.
- · Late Stage: This funding is for companies that have already gained traction on the market. At this stage, most companies have received funding and are looking for both capital and advice. They may also seek guidance as they compete with larger companies.
2. Growth Equity
Growth equity is also known as”growth capital” and “expansion capital.” In this case, firms invest in minority stakes of companies with proven business models and markets but need capital to fund an expansion strategy. Growth equity is less riskier than venture capital. The worst-case scenario would be if the company’s growth were lower than expected.
Growth equity firms that are “classics” often buy company shares from employees or investors. In this case, the company must receive cash or minimal money. It’s, therefore, more critical to pick winners and find ways to boost growth without additional capital.
Newer firms operating like late-stage VCs invest new capital to support their business growth. Many firms employ both strategies. Some of the more significant growth equity companies also perform leveraged buyouts. Growth equity is now a part of many mega-funds, including Sequoia and other VC firms.
| Read More: Private Equity Fund Structure
3. Leveraged Buyouts
The client acquires a private Equity Fund. The assets and profits of the target company secure the debt. The seller wants to purchase the target using money bought by the target as a financial security. Private equity firms will only pay a small percentage of the purchase price in a leveraged transaction. Leveraging investment allows private equity firms to maximize their potential returns.
4. Fund of Funds
Fund of Funds (FoF) or multi-manager investments are made in Private Equity funds instead of directly investing in bonds, stocks, and securities. A fund of funds is usually associated with greater investment diversification and lower risks.
These funds are often burdened with additional fees that can make them more expensive than expected. Investors can also need help locating qualified fund managers.
5. Mezzanine Financing
Mezzanine finance differs from other investment strategies because it includes debt and equity. If the debt capital is not repaid, the lender can convert the loan into equity or ownership of the company. Mezzanine funding is only available to profitable companies that have established their product or service and have a solid reputation.
Many choose growth equity to get capital without losing equity ownership, provided the debt is repaid on time and in full. Mezzanine funding is often compared to equity on a company’s balance sheet. This can make it easier for a bank to provide financing.
This is usually done by lending to less traditional institutions. The target company is usually required to pay a higher interest rate and adhere to stricter conditions.
| Read More: Hedge Fund vs Private Equity
Conclusion
Private equity is not without controversy despite its many benefits. Critics highlight job cuts, excessive borrowing, and an emphasis on short-term gain. Private equity firms can use a wide range of strategies, and their success depends on various factors, including the market conditions and specifics of each investment.
