Private Equity/Venture Capital
- PRIVATE EQUITY
Definition of private equity Private equity capital is equity capital that is not quoted on a public exchange. Private equity investors or funds make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors and can be used to fund start-ups (venture capital), make acquisitions (growth equity, buyout), or to strengthen a balance sheet (special situations). Such investments are commonly made by private equity firms, venture capital firms or “angel investors”. Investments are generally made through a fund partnership having the following characteristics:
- Private equity funds are closed-end investment structures.
- A fund’s terms and conditions are defined in a limited partnership agreement.
- The term of a fund ranges between 10 and 12 years.
- Investment disciplines include leveraged buyouts (LBO), venture capital, distressed, growth, mezzanine finance and angel investor.
- How does a private equity fund work?
- Private equity strategies
- Growth capital
The fund’s manager, or general partner, establishes a limited partnership agreement that sets forth the terms and conditions governing investment in the fund. Investors in the fund, or limited partners, fund capital calls up to their agreed commitment level for the duration of the investment period (4-6 years). Once a portfolio investment is realized – i.e. the underlying company is sold to a financial buyer, a strategic investor or gone public via an IPO – the fund distributes proceeds back to the limited partners.
Private equity funds typically employ a transformational, value-added, active investment strategy. However, diverse investment strategies can be used depending on where the company is in its life cycle. Each stage of a company’s life cycle exhibits a certain risk profile and requires a specific set of skills from the general partner. There are three principal financing stages in a company’s life cycle.
Growth capital refers to equity investments, most frequently minority investments, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change of control of the business. Buyout investments consist in acquiring a stake in a private company (non-listed or public to be taken private) with the intention to exercise influence on the company. Buyout funds usually invest in mature, established companies with a strong market position. The buyout manager draws up, together with the company’s management, a business plan to develop the company further, either organically and/or by applying a “buy and build” strategy. This process consists of acquiring a company of a significant size, and then adding smaller companies to the initial acquisition in order to create a significant player in the industry. Buyout managers will support the company’s management in its acquisition plan, negotiating possible debt financing and efficiently consolidating the business. The plan may also include some cost restructuring measures, the disposal of non-core assets or the sale of unprofitable divisions. Buyout transactions make sense when buyout capitalists believe they can extract value by holding and managing a company for a period of time and exiting it after significant value has been created. Special situations Special situations funds invest in restructuring, turnaround, distressed debt for control and any other unusual circumstances that a company can face. This category includes investments in equity and equity related instruments as well as debt instruments.
Venture Capital
- Meaning
- Venture capital means funds made available for startup firms and small businesses with exceptional growth potential.
- Venture capital is money provided by professionals who alongside management invest in young, rapidly growing companies that have the potential to develop into significant economic contributors.
- Characteristics
- Long time horizon.
- Lack of liquidity.
- High risk.
- Equity participation.
- Participation in management.
The SEBI has defined Venture Capital Fund in its Regulation 1996 as ‘a fund established in the form of a company or trust which raises money through loans, donations, issue of securities or units as the case may be and makes or proposes to make investments in accordance with the regulations’.
- Advantages
- It injects long term equity finance which provides a solid capital base for future growth.
- The venture capitalist is a business partner, sharing both the risks and rewards. Venture capitalists are rewarded by business success and the capital gain.
- The venture capitalist is able to provide practical advice and assistance to the company based on past experience with other companies which were in similar situations..
- The venture capitalist also has a network of contacts in many areas that can add value to the company.
- The venture capitalist may be capable of providing additional rounds of funding should it be required to finance growth.
- Venture capitalists are experienced in the process of preparing a company for an initial public offering (IPO) of its shares onto the stock exchanges or overseas stock exchange such as NASDAQ.
- They can also facilitate a trade sale.