private equity


  • A small increase in firm’s value – for example, a growth of asset price by 20% – can lead to 100% return on equity, if the amount the private-equity fund put down to buy the
    company in the first place was only 20% down and 80% debt.

  • However, venture capital funds have produced lower returns for investors over recent years compared to other private-equity fund types, particularly buyout.

  • By selling part of the company to private equity, the owner can take out some value and share the risk of growth with partners.

  • [76] Age of the mega-buyout: 2005–2007[edit] Main articles: History of private equity and venture capital and Private equity in the 21st century The combination of decreasing
    interest rates, loosening lending standards and regulatory changes for publicly traded companies (specifically the Sarbanes–Oxley Act) would set the stage for the largest boom private equity had seen.

  • This form of financing is often used by private-equity investors to reduce the amount of equity capital required to finance a leveraged buyout or major expansion.

  • [13] As a percentage of the purchase price for a leverage buyout target, the amount of debt used to finance a transaction varies according to the financial condition and history
    of the acquisition target, market conditions, the willingness of lenders to extend credit (both to the LBO’s financial sponsors and the company to be acquired) as well as the interest costs and the ability of the company to cover those costs.

  • Investor categories[edit] US, Canadian and European public and private pension schemes have invested in the asset class since the early 1980s to diversify away from their
    core holdings (public equity and fixed income).

  • [98] Investments in private equity Although the capital for private equity originally came from individual investors or corporations, in the 1970s, private equity became an
    asset class in which various institutional investors allocated capital in the hopes of achieving risk-adjusted returns that exceed those possible in the public equity markets.

  • [22] A private investment in public equity (PIPE), refer to a form of growth capital investment made into a publicly traded company.

  • [29][35] Investors generally commit to venture capital funds as part of a wider diversified private-equity portfolio, but also to pursue the larger returns the strategy has
    the potential to offer.

  • [43][44] Often investments in secondaries are made through third-party fund vehicle, structured similar to a fund of funds although many large institutional investors have
    purchased private-equity fund interests through secondary transactions.

  • Nevertheless, private equity continues to be a large and active asset class and the private-equity firms, with hundreds of billions of dollars of committed capital from investors
    are looking to deploy capital in new and different transactions.

  • However, if the private-equity firm fails to make the target grow in value, losses will be large.

  • Other strategies[edit] Other strategies that can be considered private equity or a close adjacent market include: • Real estate: in the context of private equity this will
    typically refer to the riskier end of the investment spectrum including “value-added” and opportunity funds where the investments often more closely resemble leveraged buyouts than traditional real estate investments.

  • ARDC is credited with the first major venture capital success story when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC) would be valued at over $355
    million after the company’s initial public offering in 1968 (a return of over 5,000 times its investment and an annualized rate of return of 101%).

  • However, when private equity purchases a larger firm, the experience of being managed by private equity may lead to loss of product quality and low morale among the employees.

  • The fund of funds model is used by investors looking for: • Diversification but have insufficient capital to diversify their portfolio by themselves • Access to top-performing
    funds that are otherwise oversubscribed • Experience in a particular fund type or strategy before investing directly in funds in that niche • Exposure to difficult-to-reach and/or emerging markets • Superior fund selection by high-talent fund
    of fund managers/teams • Search fund: A search fund is an investment vehicle through which an entrepreneur (called a “searcher”) raises funds from investors in order to acquire an existing small business.

  • [29][30] Venture capital is often sub-divided by the stage of development of the company ranging from early-stage capital used for the launch of startup companies to late
    stage and growth capital that is often used to fund expansion of existing business that are generating revenue but may not yet be profitable or generating cash flow to fund future growth.

  • [83] Additionally, U.S.-based private-equity firms raised $215.4 billion in investor commitments to 322 funds, surpassing the previous record set in 2000 by 22% and 33% higher
    than the 2005 fundraising total[84] The following year, despite the onset of turmoil in the credit markets in the summer, saw yet another record year of fundraising with $302 billion of investor commitments to 415 funds[85] Among the mega-buyouts
    completed during the 2006 to 2007 boom were: EQ Office, HCA,[86] Alliance Boots[87] and TXU.

  • These investment vehicles would utilize a number of the same tactics and target the same type of companies as more traditional leveraged buyouts and in many ways could be
    considered a forerunner of the later private-equity firms.

  • [58] Origins of the leveraged buyout[edit] Main articles: History of private equity and venture capital and Early history of private equity The first leveraged buyout may
    have been the purchase by McLean Industries, Inc. of Pan-Atlantic Steamship Company in January 1955 and Waterman Steamship Corporation in May 1955[59] Under the terms of that transaction, McLean borrowed $42 million and raised an additional
    $7 million through an issue of preferred stock.

  • Secondary investments allow institutional investors, particularly those new to the asset class, to invest in private equity from older vintages than would otherwise be available
    to them.

  • Growth capital[edit] Main article: Growth capital Growth capital refers to equity investments, most often 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.

  • [69][70][71] Many of the corporate raiders were onetime clients of Michael Milken, whose investment banking firm, Drexel Burnham Lambert helped raise blind pools of capital
    with which corporate raiders could make a legitimate attempt to take over a company and provided high-yield debt (“junk bonds”) financing of the buyouts.

  • This kind of financing structure leverage benefits an LBO’s financial sponsor in two ways: (1) the investor only needs to provide a fraction of the capital for the acquisition,
    and (2) the returns to the investor will be enhanced, as long as the return on assets exceeds the cost of the debt.

  • [68] During the 1980s, constituencies within acquired companies and the media ascribed the “corporate raid” label to many private-equity investments, particularly those that
    featured a hostile takeover of the company, perceived asset stripping, major layoffs or other significant corporate restructuring activities.

  • Each of these categories of investors has its own set of goals, preferences and investment strategies; however, all provide working capital to a target company to nurture
    expansion, new-product development, or restructuring of the company’s operations, management, or ownership.

  • [9] Private-equity firms view target companies as either Platform companies, which have sufficient scale and a successful business model to act as a stand-alone entity, or
    as add-on / tuck-in / bolt-on acquisitions, which would include companies with insufficient scale or other deficits.

  • Venture capital[edit] Main article: Venture capital Venture capital[28] or VC is a broad subcategory of private equity that refers to equity investments made, typically in
    less mature companies, for the launch of a seed or startup company, early-stage development, or expansion of a business.

  • [36][37][38] The “distressed” category encompasses two broad sub-strategies including: • “Distressed-to-Control” or “Loan-to-Own” strategies where the investor acquires debt
    securities in the hopes of emerging from a corporate restructuring in control of the company’s equity;[39] • “Special Situations” or “Turnaround” strategies where an investor will provide debt and equity investments, often “rescue financing”
    to companies undergoing operational or financial challenges.

  • [33] The venture capitalist’s need to deliver high returns to compensate for the risk of these investments makes venture funding an expensive capital source for companies.

  • To do this, the financial sponsor will raise acquisition debt, which looks to the cash flows of the acquisition target to make interest and principal payments.

  • • Private equity makes extensive use of debt financing to purchase companies in use of leverage.

  • • Often the loan/equity ($11bn in the example) is not paid off after the sale, but left on the books of the company (XYZ Industrial) for it to pay off over time.

  • [42] By its nature, the private-equity asset class is illiquid, intended to be a long-term investment for buy and hold investors.

  • Marked by the buyout of Dex Media in 2002, large multibillion-dollar U.S. buyouts could once again obtain significant high yield debt financing and larger transactions could
    be completed.

  • When a private equity firm purchases a small startup it can behave like venture capital and help the small firm reach a wider market.

  • Private equity (PE) typically refers to investment funds, generally organized as limited partnerships, that buy and restructure companies.

  • [5][6] • Private-equity investors often syndicate their transactions to other buyers to achieve benefits that include diversification of different types of target risk, the
    combination of complementary investor information and skillsets, and an increase in future deal flow.

  • These companies are likely to be more mature than venture capital-funded companies, able to generate revenue and operating profits, but unable to generate sufficient cash
    to fund major expansions, acquisitions or other investments.

  • Secondaries also typically experience a different cash flow profile, diminishing the j-curve effect of investing in new private-equity funds.

  • [99] For most institutional investors, private-equity investments are made as part of a broad asset allocation that includes traditional assets (e.g., public equity and bonds)
    and other alternative assets (e.g., hedge funds, real estate, commodities).

  • • Most buyout deals are much smaller; the global average purchase in 2013 was $89m, for example.

  • Certain investors in private equity consider real estate to be a separate asset class.

  • [2] Private equity is also often grouped into a broader category called “private capital”, generally used to describe capital supporting any long-term, illiquid investment

  • This is distinct from a venture-capital or growth-capital investment, in which the investors (typically venture-capital firms or angel investors) invest in young, growing
    or emerging companies, but rarely obtain majority control.

  • [citation needed] As a result of the global financial crisis, private equity has become subject to increased regulation in Europe and is now subject, among other things, to
    rules preventing asset stripping of portfolio companies and requiring the notification and disclosure of information in connection with buy-out activity.

  • These transactions can involve the sale of private-equity fund interests or portfolios of direct investments in privately held companies through the purchase of these investments
    from existing institutional investors.

  • Being able to secure financing is critical to any business, whether it is a startup seeking venture capital or a mid-sized firm that needs more cash to grow.

  • Mezzanine capital, which is often used by smaller companies that are unable to access the high yield market, allows such companies to borrow additional capital beyond the
    levels that traditional lenders are willing to provide through bank loans.

  • Direct versus indirect investment[edit] Most institutional investors do not invest directly in privately held companies, lacking the expertise and resources necessary to structure
    and monitor the investment.

  • [40] In addition to these private-equity strategies, hedge funds employ a variety of distressed investment strategies including the active trading of loans and bonds issued
    by distressed companies.

  • Private equity in the 1980s[edit] Main articles: History of private equity and venture capital and Private equity in the 1980s In January 1982, former United States Secretary
    of the Treasury William E. Simon and a group of investors acquired Gibson Greetings, a producer of greeting cards, for $80 million, of which only $1 million was rumored to have been contributed by the investors.

  • In 2006, private-equity firms bought 654 U.S. companies for $375 billion, representing 18 times the level of transactions closed in 2003.

  • Uncertain market conditions led to a significant widening of yield spreads, which coupled with the typical summer slowdown led many companies and investment banks to put their
    plans to issue debt on hold until the autumn.

  • History and development Early history and the development of venture capital[edit] Main articles: History of private equity and venture capital and Early history of private
    equity The seeds of the US private-equity industry were planted in 1946 with the founding of two venture capital firms: American Research and Development Corporation (ARDC) and J.H.

  • [52] As well as this to compensate for private equities not being traded on the public market, a private equity secondary market has formed, where private equity investors
    purchase securities and assets from other private equity investors.

  • More formally, private equity is a type of equity and one of the asset classes consisting of equity securities and debt in operating companies that are not publicly traded
    on a stock exchange.

  • [94] But with the increased availability and scope of funding provided by private markets, many companies are staying private simply because they can.

  • [89][90] The markets had been highly robust during the first six months of 2007, with highly issuer friendly developments including PIK and PIK Toggle (interest is “Payable
    In Kind”) and covenant light debt widely available to finance large leveraged buyouts.

  • Because of this lack of scale, these companies generally can find few alternative conduits to secure capital for growth, so access to growth equity can be critical to pursue
    necessary facility expansion, sales and marketing initiatives, equipment purchases, and new product development.

  • • A private-equity manager uses the money of investors to fund its acquisitions.

  • Many of these companies lacked a viable or attractive exit for their founders as they were too small to be taken public and the founders were reluctant to sell out to competitors
    and so a sale to a financial buyer could prove attractive.

  • McKinsey & Company reports in its Global Private Markets Review 2018 that global private market fundraising increased by $28.2 billion from 2017, for a total of $748 billion
    in 2018.

  • [41] Secondaries[edit] Main article: Private equity secondary market Secondary investments refer to investments made in existing private-equity assets.

  • • Innovations tend to be produced by founders at startups rather than existing organizations, private equity firms targets startups to create value by overcoming agency costs
    and better aligning the incentives of corporate managers with those of their shareholders.

  • [49] • Fund of funds: investments made in a fund whose primary activity is investing in other private-equity funds.

  • [20] The primary owner of the company may not be willing to take the financial risk alone.


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