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WHAT IS PRIVATE EQUITY?
Private equity is the category of capital investments made into private companies. Private equity firms invest in private companies by purchasing shares with the expectation that they’ll be worth more than the original investment by a specified date. These firms allocate investment money from institutional investors, such as mutual funds, insurance companies, or pensions, and high-net-worth individuals
In addition to funding, the relationship between a private equity firm and the companies it invests in can include mentorship and industry expertise. This can be a great value-add for companies that receive the investments because they’re typically at a point in their lifecycles where growth and change are needed.
3 TYPES OF PRIVATE EQUITY STRATEGIES
Venture Capital
Venture capital (VC) is a type of private equity investment made in an early-stage startup. Venture capitalists give the company a certain amount of seed funding in exchange for a share of it. Venture capitalists typically don’t require a majority share (over 50 percent), which can be attractive to founders.
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Venture capital investing is inherently risky because startups—many of which are little more than ideas at the time of a pitch—haven’t yet proven their ability to turn a profit. Like with any investment, venture capital’s return on investment is never a guarantee. Yet, when a startup turns out to be the next big thing, venture capitalists can potentially cash in on millions, or even billions, of dollars.
Growth Equity
Buyouts
The final key private equity strategy—and the one that’s furthest along in the company lifecycle—is buyouts. Buyouts occur when a mature, typically public company is taken private and purchased by either a private equity firm or its existing management team. This type of investment makes up the largest portion of funds in the private equity space.
When a buyout occurs, all of the company’s previous investors cash in on their shares and exit. The private equity firm or management team becomes the sole investor and must hold a controlling share of the company (more than 50 percent).
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There are two types of buyouts:
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Management buyouts, in which the existing management team buys the company’s assets and takes the controlling share
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Leveraged buyouts, which are buyouts funded with borrowed money
Growth equity comes into play further along in a company’s lifecycle: once it’s established but needs additional funding to grow. As with venture capital, growth equity investments are granted in return for company equity, typically a minority share. Unlike venture capitalists, growth equity investors can research the company’s financial track record, interview clients, and try the product themselves before deciding if the company is a wise investment choice. Any investment presents risk, but in the case of growth equity, the company has the chance to prove it can provide a return before the private equity firm invests.
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Many firms involved in growth equity maintain a database of up-and-coming companies and track their financial information over time, sometimes for as long as 10 or 15 years. This allows firms to flag companies earning revenue and growing at a fast clip, and reach out to them when they appear to need funding to continue expanding.