Common Private Equity Strategies for Investors

2017, 05 Dec | In Investment Banking, M & A for Entreprenuers

Common Private Equity Strategies for Investors

Private equity are assets consisting of equity securities and debt in operating companies not traded publicly on a stock exchange. A private equity investment is usually made by a private equity firm, a venture capital firm, or an investor. Each of these investors has its own goals and missions but they all follow the same rule:

The investors provide working capital to a company in order to foster growth, development, or a restructuring of the company.

There are many private equity strategies that an investor should know about:

Growth Capital

Growth Capital usually involves minority investments in mature companies looking for capital to expand or restructure operations, finance a major acquisition or enter new markets.

Companies involved in Growth Capital typically can generate revenue and operating profits, but don’t generate enough cash to fund major expansions, acquisitions, or other investments. This lack of scale can make it challenging for these companies to secure capital for growth, making access to growth equity difficult.

The primary owner doesn’t have to take on the financial risk alone by selling part of the company to private equity, but can take out some value and share the risk of growth with partners.


Leveraged Buyouts

Leveraged buyouts (or LBO) is used by a company when capital acquired from loans or bonds to acquire another company.  Usually, companies involved in LBO transactions are mature and generate cash flows.

If a private equity company is confident that they can increase the value of a company over time, the firm pursues a buyout investment

Leveraged buyouts involve a financial sponsor, who agrees to an acquisition without committing all the money required. The financial sponsor raises the acquisition debt, which looks to the cash flows of the acquisition target to make interest and principal payments.

Historically, the debt portion of a LBO ranges from 60%–90% of the purchase price.

Mezzanine Capital

Private equity investors use Mezzanine Capital, or Mezzanine Financing, in order to reduce the amount of equity capital required to finance a leveraged buyout or major expansion. The subordinated debt (or preferred equity) securities represents a junior portion of a company’s capital structure that’s senior to the firm’s common equity.

Mezzanine Capital is usually used by smaller companies unable to access a high yield market. This strategy provides companies the opportunity to access additional capital – beyond what traditional lenders are willing to provide.

However, because of the increased risk, debt holders require a higher return on investment, when compared to other more senior lenders.

Benefits of Mezzanine Capital include being able to receive the capital needed without giving up a considerable amount of equity ownership.

Venture Capital

Venture Capital usually involves less mature companies, start-up companies, or companies in early-stage development. One will notice venture investments applied toward new technology, new marketing concepts, or new products that don’t have a proven track record or reliable revenue streams yet.

The products and ideas developed by entrepreneurs require substantial capital that business people don’t have access to.  Often, they will turn to venture capitalists. The VC’s need for high returns (in order to compensate for the increased risk of these types of investments) makes this a potentially expensive money source for any company.

Venture Capital is most suited for businesses that face large up-front capital requirements that are unable to be financed by alternative sources like debt.

Distressed & Special Situations

This is a broad category that refers to investments in equity or debt securities of financially stressed companies.

The term “distressed” involves two sub-strategies:

  1. Distressed-to-Control, or Loan-to-own – Where the investor secures new debt securities, anticipating they will gain control of the company’s equity following a restructuring.
  2. Special Situations (or Turnaround) – Where an investor provides debt and equity investments to companies undergoing significant challenges. Special situations may include mergers and acquisitions, bankruptcy and more.

It’s worth noting that in addition to private equity funds, hedge funds also employ this investment strategy.

Other types of strategies considered private equity include:

Real Estate: Usually refers to the gathering of investor capital to invest in various real estate properties. Often considered a risky investment, this includes “value added” and opportunity funds.

Funds of Funds: This type of strategy involves investing in a fund whose purpose is to invest in other private equity funds. This strategy is employed by investors looking for diversification, access to top-performing funds, experience in a specific type of fund prior to investing, or exposure to hard-to-reach or emerging markets.

One can have a better chance to suceed when following one of the above strategies.