April 18, 2024

Business Bib

Business & Finance Blog

Private Equity Explained for Investors 

3 min read

 

Private equity refers to an alternative investment class. It consists of a capital not on a public exchange and composed of funds and investors that directly invest in private companies, or those that engage in buyouts of public companies.

In this type of financing, retail and institutional investors offer the capita for private equity. The capital can then be utilized to fund new technology, make acquisitions, expand working capital, and to boost and solidify a balance sheet. 

Private Equity Advantages 

Private equity offers several advantages to companies and budding startups. Companies like it because it allows them to access liquidity as an alternative to the traditional financial mechanisms, like high interest bank loans or listing on public markets. 

There are certain types of private equity, like venture capital, which finance ideas and early stage companies.

For companies that have been delisted, private equity financing can help such companies try unorthodox growth strategies away from the glare of public markets. 

Otherwise, the pressure of quarterly earnings dramatically diminishes the time frame available to senior management to turn a company around or experiment with new ways to cut the losses and eventually make money. 

Private Equity Disadvantages 

Private equity comes with its own inherent downsides.

For one, it may be difficult to liquidate holdings in private equity since a read-made order book that matches with potential sellers is no available, unlike in public markets. A company must undertake to find a buyer to make a sale of its investments or company. 

Also, the pricing of the shares of a company in private equity is gotten through discussions between buyers and sellers, not by market forces. 

The rights of private equity shareholders are also generally decided on a case-by-case basis through negotiations rather than broad governance framework. 

How Does It Work? 

Private equity firms raise money from institutional investors and accredited investors for funds that invest in different types of assets. Here are the most popular types of private equity funding. 

Distressed Funding  

Distressed funding is also called vulture funding since the money in this type of fund is invested in troubled companies that have underperforming business units or assets.

The goal is to turn them around by making necessary adjustments to their management or operations or make a sale of their asset in order to profit. 

Leveraged Buyouts 

This is the most popular type of private equity funding. It involves buying out a company completely, and the goal is to improve its business and financial health to resell it for a profit to an interested party or conducting an IPO.

Real Estate Private Equity 

After the 2008 financial crisis, real estate private equity saw a surge. Typical areas where funds go are commercial real estate and real estate investment trusts. 

Funds of Funds 

As the name suggests, funds of funds mainly focus on investing in other funds, mostly mutual funds and hedge funds. They often offer a backdoor entry to an investor who cannot afford minimum capital requirements in such funds. 

Venture Capital 

This is form of financing in which investors provide capital to entrepreneurs. Depending on the stage at which it is provided, venture capital can take several forms. 

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