How Does Private Equity Work?
The process of private equity can be a bit complex for the untrained professional. This is where a qualified venture capitalist like Efraim Landa can prove extremely beneficial. If you are starting out in finance, the assistance of a private equity firm is very advantageous on multiple levels. Below is a comprehensive look at the basics of private equity and how it works.
What is private equity?
Private equity in financial terms is simply an asset class that consists of equity securities and debt in operating companies which are not already publicly traded on a stock exchange. These types of investments are typically made by a private equity firm or an angel investor. Essentially, each category of investor also has a set of goals, preferences and investment strategies while all provide working capital to a target company. This working capital is meant to nurture growth through new product development or general restructuring.
This form of investment capital comes from high net worth individuals with an aim of investing and acquiring equity ownership in businesses. The investment in those particular corporations will typically be made by a private equity firm. However, they can also be made by a venture capital firm or an angel investor.
How do private equity funds acquire a firm?
One of the most common ways that funds get acquired by firms is through the leveraged buyout or LBO. A leveraged buyout is the takeover of a company whether it is in part of the assets or in its entirety. This is done using private equity funding along with borrowed funds from lending institutions or banks.
These funds can be used to purchase all of the company’s shares which are public. Additionally, the money can be used to buy out a firm’s owners in the case that it is not a public firm. Some of the other ways private equity can be utilized in taking over firms often consist of using the funds to expand a firm or to pay off a debt. This would allow the private equity holders control of the company in each instance.
How do private equity investors make money back?
Private equity investors will usually receive a return on their investment in one of three ways:
• Initial public offering (IPO) – This occurs when shares of the company are offered to the public. Generally, this provides an immediate return on the investment through the successful selling of shares in the firm.
• Merger or acquisition – In a merger or acquisition, the business is sold for either cash or shares in another business entity.
• Recapitalization – This is the basic distribution of cash to shareholders or investors. It can be either from cash flow that the company has generated or through raising debt or other securities in order to finance the distribution.
When did private equity begin in the United States?
Private equity investment has been traced back to 1901 when J.P. Morgan managed the very first recorded leveraged buyout of the Carnegie Steel Company where he used private equity. Most private equity investments remained only within reach of wealthy individuals or families until World War II.
Today’s modern private equity is often said to have started back in 1946 with credit being owed to Georges Doriot. He is often referred to as the “father of venture capitalism” since his founding of ARDC and INSEAD. These were both funded with capital raised from institutional investors in order to promote private sector investments in companies which were run by soldiers returning from the war.
What are some of the larger private equity firms now in operation?
Currently, the largest private equity firms are based on the amount of funds they attract include: Bain Capital, Goldman Sachs, The Carlyle Group and The Blackstone Group.
What are the advantages and disadvantages of private equity?
Those who are critical of private equity often claim that in order to grow their investment with a quick sale of the firm they are currently controlling, private equity investors will replace senior management while reducing the workforce and selling off assets. This is fundamentally gutting the entire business for profit.
On the other hand, those who support private equity know that it attracts only the best and brightest in corporate America. The professionals at these types of firms are generally successful by increasing the values of the businesses they control or eventually sell off.
Posted on May 30, 2014, in Private Equity Firms, Venture Capital and tagged Effi Enterprises, IPO, mergers and acquisitions, Private Equity, US venture capital. Bookmark the permalink. Leave a comment.