We’ve had lots of questions form you guys following our business investment feature to expand a little more on what private equity is and how it differs from other investment vehicles such as venture capital. To help us to give you the most accurate information we have the wonderful Tyler Tysdal with us, a man who has been a private investor, a fund manager and someone who has dedicated their career to the investment of business. Hopefully this quick guide answers those burning questions which you may have about what private equity is.
Private equity is simply the investment in a privately traded business, whereby the investment funds looks to buy a large chunk or all of the shares in a company. The aim of the investment vehicle is to offer financial support and expertise to help it reach its goals for growth or to save a company which is going through difficulties. The PE company will look for a seat on the board or total control of a company, they will then use their cash and their knowledge to turn things around and then they will sell off their shares, spreading the profits out amongst their pool of investors.
Private Equity Example
The most common strategy within private equity is what is called a leveraged buy out, and this is an example of how that may work.
- Company A is losing money and the value of the company is decreasing
- Private equity group borrow $2bn from the bank and inject $4bn from their fund to buy the company
- Assets are sold, workforce is streamlined and management team replaced to boost business
- When the market is buoyant and the company value has risen, PE firm sells its shares for $8bn
- Loan is repaid to the bank and remainder of the $2bn profit shared amongst the investors
This is a basic example of how leveraged buyouts generally work, naturally there is much more detail in the actual takeover of such a company.
How it Differs From Venture Capital
On the face of it both venture capital and private equity may seem to be similar because they are both investment funds which look to buy a significant stake in a company. With this being said however there are some fundamental differences between these two investment vehicles. Venture capital focuses on the purchase of shares in a new company, a startup. They will focus on rapid growth industries such as tech or chemicals, and they will look to buy up to 49% of the company. There is much more risk attached with the venture capital investment because the company that they are investing in, doesn’t have any history to indicate that they will be a sound investment. A venture capital investment will include a lot of involvement from the firm to impact opportunities and to use their knowledge and money to give the startup the best chance of success. Risk levels, stage of investment, share breakup and industries are all stark differences between venture capital and private equity.