In the world of finance, private equity is a class of assets with equity securities in companies that are not on the stock exchange or publicly traded. Private equity firms, angel investors or venture capitalists usually make a private equity investment in order to provide a business with the money they need to expand, develop a new product or restructure their operations, management team or ownership.
However, the investment strategy differs among these investors and each one has a certain goal they are trying to accomplish. There are five popular strategies utilized by private equity investors:
In a leveraged buyout, or LBO, equity investments are made as part of an agreement where a company or business assets are acquired from the company’s shareholders, by way of financial leverage.
Leveraged buyouts have a financial sponsor who agrees to the arrangement, but does not provide all the money needed for the acquisition. This is made possible by having the financial sponsor raise the acquisition debt and it is the responsibility of the acquisition target to make the principal and interest payments.
Leveraged buyouts are structured in such a way that the investor only has to put up a small portion of the money needed for the acquisition and the investor’s returns will be greater as long as the return on assets is more than the actual debt.
This type of private equity targets businesses that are still in the start-up phase. Many cannot secure a regular bank loan so a venture capitalist will provide them the funding they need to get their business up and running.
Most of these companies are involved in creating new technologies or new products that have no history of success so venture capitalists take a great risk by investing in them. However, most venture capitalists play a huge role in the company and many times have a majority stake in the business.
As the name implies, this type of private equity investment involves providing capital for companies that are already in operation and are mature, but they either want to expand, restructure, tap into a new market or finance a big acquisition. They want to do this without changing who controls the business.
This type of private equity strategy usually refers to investing in equity or debt securities of companies that are struggling financially. There are two categories of distressed investments—distressed-to-control and special situations.
This means of private equity investing reduces the equity capital that is required to finance either a leveraged buyout or a major expansion of the business.
Mezzanine capital lets these smaller companies borrow more capital than what most lenders will give them through traditional bank loans. Because there is a high amount of risk, mezzanine debt holders demand a much higher return on their investment.
Other private equity strategies include secondary investments, infrastructure, real estate and fund of funds. Each one has its own unique set of rules and procedures. Private equity is a very important part of keeping companies funded during difficult times or in times of transition.