PRIVATE EQUITY UK
The term ‘private equity’ encompasses a range of techniques used to finance commercial ventures in ways that do not involve the use of publicly trade-able assets such as corporate shares or bonds. Typical forms of private equity include venture capital, growth and mezzanine capital, angel investing and private equity funds. Private equity investors seek to obtain a substantial interest in a company in order to gain control over the firm’s management. Their goal is to boost the value of a company, sell off their investment, and walk away with substantially more money than they put in.
Private equity investors tend to be either institutions or very wealthy individuals, so the average worker might not directly experience the ways in which private equity has an impact upon corporate strategy and governance. Nevertheless, private equity can have a significant impact on how your company is run or the way it positions itself to compete in the current business environment.
On the modest end, if you work for a small business that’s received private equity funding or a start-up backed by venture capital, it’s very likely that private equity investors play a significant role in your company’s board of directors. On a day-to-day basis, you’re likely to see higher expectations for sales targets and new business goals. If senior management can't meet those objectives, expect to see new faces in the office soon.
TYPES OF PRIVATE EQUITY INVESTING
Each has its own subcategories and dynamics and whilst this is simplistic, it provides a useful basis for portfolio construction.
- Seed
- Start-up
- Expansion
- Replacement Capital
- Buyout
Venture capital is investing in companies that have undeveloped or developing products or revenue.
- Seed Stage: Financing provided to research, assess and develop an initial concept before a business has reached the start-up phase.
- Start-up Stage: Financing for product development and initial marketing. Companies may be in the process of being set up or may have been in business for a short time, but have not sold their products commercially and are not yet generating a profit.
- Expansion Stage: Financing for growth and expansion of a company which is breaking even or trading profitably. Capital may be used to finance increased production capacity, market or product development, and/or to provide additional working capital.
- Replacement Capital: Purchase of shares from another investor or to reduce gearing via the refinancing of debt.
- Buyout: A buyout fund typically targets the acquisition of a significant portion or majority control of businesses which normally entails a change of ownership. Buyout funds usually invest in more mature companies with established business plans to finance expansions, consolidations, turnarounds and sales, or spinouts of divisions or subsidiaries. Financing expansion through multiple acquisitions is often referred to as a ‘buy and build’ strategy. Investment styles can vary widely, ranging from growth to value and early to late stage. Furthermore, buyout funds may take either an active or a passive management role.
- Special Situations: Special situation investing ranges more broadly, including distressed debt, equity-linked debt, project finance, one-time opportunities resulting from changing industry trends or government regulations, and leasing. This category includes investment in subordinated debt, sometimes referred to as mezzanine debt financing, where the debt-holder seeks equity appreciation via such conversion features as rights, warrants or options.
The spectrum of investors in private equity has expanded rapidly to include different types of investors with significant long-term commitments to the asset class. The majority of commitments to private equity funds based in respective geographical regions have come from institutions within the same region. This is evolving as investors seek a higher level of geographical diversification in their private equity portfolios.
PROS
Private equity firms specialize in increasing the value of their holdings by reinvigorating the management of a company. This can mean strengthening leadership, refocusing strategy, reducing cost structures, instituting growth initiatives, or even breaking up the company to sell it in parts. When it works as intended, the result is more efficient use of capital, which in turn fuels the economy and drives innovation.
THE WEAK AREAS
Critics charge that private equity investors seek to boost the value of a company as quickly possible, with little regard for intangible factors such as company history, culture, or workplace environment. In other words, while private equity is great for investors, it may not be so much fun for the companies they invest in or the people who work for them.
Over 8 in 10 private equity firms holding a stake in technology companies plan to acquire at least one other IT business this year, according to a survey.
84% of those equity companies planned to make an acquisition in the U.K by the end of the year and 72% expect the overall level of private equity investment in the country’s technology sector to increase.
9 of 10 private equity firms said they would most favour buying into cloud computing companies, as businesses took opportunities to cut costs by paying for software on demand. About 39% said they would consider green IT acquisitions, as new technology emerges and the government backs more environmental initiatives.
Nevertheless, the survey cautioned that the recession was still having an effect and any acquisitions of IT companies were likely to be smaller in size. It’s research found that 86% of private equity transactions last year were under £100 million, a greater proportion than two years ago when 67% were in that range.
The fundamental reason for investing in private equity is to improve the risk and reward characteristics of an investment portfolio. Investing in private equity offers the investor the opportunity to generate higher absolute returns whilst improving portfolio diversification.
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