Private Equity

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What It Means

Private Equity refers to capital investment in private companies. Private Equity firms raise money from high net worth individuals and institutional funds, such as pension funds, and use that money to invest in or acquire one or more private companies.

Private Equity companies tend to specialize in investing in companies that meet specific criteria, such as size, geographic location, or market segment. Some of the more common types of Private Equity specializations include:

• Venture Capital - Venture Capital firms, commonly known as VCs, invest in startups and early stage companies. VCs typically prefer to make minority investments in several companies that have high growth potential. Venture Capital is considered a very risky investment class and VCs know that many, if not most, of their portfolio companies may fail to generate positive returns.

• Growth Equity - Growth Equity firms invest in more mature companies. These firms provide companies with the capital needed to scale their operations and fund growth. Growth Equity is less risky than Venture Capital because the companies involved are larger and more established in their respective markets.

• Leveraged Buyouts - Leveraged Buyouts, often referred to as LBOs, refer to the acquisition of a controlling stake in a company using a combination of equity capital and debt, hence the term leveraged. LBOs typically utilize debt to provide 50% or more of the capital for an Acquisition. The higher the proportion of Acquisition capital coming from debt, the more risky the investment.

• Turnarounds - Turnarounds involve the investment in or Acquisition of struggling companies. Turnaround investors believe that through proper management, a company’s struggles can be overcome and the company’s valuation prospects can be improved.

Why It’s Important

Private Equity plays a vital role in powering the Acquisition demand for Middle Market companies that have reached a size threshold to generate their interest. Private Equity firms create value for themselves and their investors in a number of ways, including growing revenues, utilizing financial engineering, and reducing costs. Creating value through growing revenues is an obvious solution. Financial Engineering involves using debt to help finance the purchase and paying off that debt over time using cash flows provided by the acquired company. The reduction of costs is often the hardest factor for Sellers to get comfortable with because the cost cutting can come at the expense of employees. Sellers considering an offer from a Private Equity firm should spend some time evaluating whether these factors and the implications they represent for the company and its employees align with their goals and values.

Related Terms

• Acquisition

• Business Valuation

• Buyout

• Carried Interest (“Carry”)

• Family Office

• Holding Company

• Turnaround

• Venture Capital

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