Understanding Private Equity: Explaining What it Is and Some of the Types

Understanding Private Equity

Whether you’re a business owner or looking to start a career in investing, you’ll have at least heard of private equity. It may have sounded complicated and confusing, but it can be important to understand—luckily, this article is here to help you with just that.

We’ll define private equity and explain a few different types of private equity investments to help you further understand what it is and how it applies to many industries, from real estate equity to automotive private equity. We’ll start with a general definition.

Private Equity

Private equity is when someone invests heavily in or outright purchases a company to manage and later sell them. The purpose of this industry is to improve companies’ profitability, help them grow, and make them more valuable in general. Private equity funds are classified as alternative investments, usually done through investment firms.

It takes pressure off the current owners and management by placing the burdens of company leadership on an outside investor. They then can implement their plan to create value, usually by restructuring the company or finding ways to cut costs. They can use their knowledge, experience, and resources to provide the newly acquired company with access to technology and resources they would have otherwise lacked.

The private equity industry does see some criticism. They’re viewed negatively by many, and their fast-paced strategy implementation can cause strain on both the employees of the company and the community. However, while some private equity buyers focus on quickly increasing value so they can resell fast, others focus on long-term changes that may be difficult to adjust to initially but will lay the groundwork for more profit in the future.

How this works varies based on which type of investment the firm specializes in and what the company needs. Below, we’ll break down a few types of private equity investments.

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Venture Capital

Most private equity firms focus on companies that have been around for a bit. There are benefits to this, as you can see how this company has been successful and what needs to happen to maintain the current level of success and launch the company into stardom. However, some prefer to invest in young start-ups, which is called venture capital.

Venture capitalist firms will provide the company with money in exchange for shares. Those who invest in venture capital are taking a risk as the companies they invest in are fresh and may not succeed for several reasons. Sometimes, the companies that receive investment are so new that they’re only making pitches and throwing out their plans without knowing how well those ideas will work. It isn’t all bad, though, as venture capitalists tend to see consistent success once they’ve succeeded once.

They’ll have learned the best ways to get a company started on the right foot and may be able to tell which ideas to run with and which ones to put on the back burner or even discard completely. Eventually, investors will be able to tell which people have the fire and determination to succeed and which may not.

If you’re not willing to take a risk on a new company, then maybe consider one of the following investment types instead. While we’ll cover leveraged buyouts later and how different they are from venture capital investments, we’ll cover growth equity next.

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Growth Capital

Growth capital goes by many names, such as growth equity and expansion capital, which all refer to investments made into a company that wishes to grow.

These companies are more mature than venture capitalists invest in but are younger than those that see buyouts. As expected, the investment firm receives a share of the company and provides funding for growth. Since the company will have been around for a bit, potential investors can do a bit of research and form a more educated opinion of the business, which allows investors to see how well a company performs before they decide to invest.

Growth capital investments are more stable, but there is still risk involved. A company would be able to show you how well they’re currently doing and may request funds to rent more space for selling or behind-the-scenes work, for more equipment, more employees, maybe for better marketing, etc. While these investments can fall flat, the track record provides some more comfort in the current owner and can demonstrate how high the chance of success actually is.

Growth capital investments are considered the bridge between venture capital and leveraged buyouts. We already know that venture capital invests in startups, so what does this mean for buyouts?

Leveraged Buyout

There are many different types of buyouts, but we’ll focus on leveraged buyouts here. Leveraged buyouts are when the assets of both the company purchasing and the purchased company are used as collateral for the loan used to make said purchase. This is necessary as buyouts tend to happen with mature companies.

The benefits to the original owner can be large as they receive a payout and may not need to be in charge of their company anymore, and the benefits to the purchaser are plenty as they’ve invested in a company that has worked for a while already.

So long as the buyer can see what works and what doesn’t and can make the correct changes, this deal should pan out incredibly well for them. The goal is for the investor to take a public company private and reorganize it for bigger profits and returns.

There will always be risks, no matter which investment firm you decide to work with or which investment type you pursue. Demand fluctuates constantly, and while some changes are predictable, many are much harder to foresee. However, if you’re willing to take this risk and can handle the consequences should they not pan out, private equity investments can be a lucrative business.