Private Equity & Venture Capital Concepts

I. PRIVATE EQUITY INVESTMENTS

1. HISTORY OF PRIVATE EQUITY–

♦  Private Equity (here-in-after referred to as “PE” for brevity purposes) has hoarded the mainstream spotlight only in the last three decades.

♦ JP Morgan is said to have conducted the first leveraged buyout (LBO) of Carnegic Steel Corporation.

♦ PE firms remained on the sidelines of the financial ecosystem after World War – II until the 1970s, when venture capitalists began bankrolling.

♦ During 1970s & 1980s, PE funding became a popular avenue for struggling companies to raise funds, away from public markets.

♦ Study found that companies backed by private equity performed better than their counterparts in the public markets.

♦ The initial PE firms included American Research & Development Corporation (ARDC) and J.H. Whitney & Co., both founded in 1946.

2. MEANING–

Private Equity refers to an alternate investment which consists of ‘capital’, that is not listed on stock exchange.

Private Equity funding refers to a type of financing, whereby capital is invested by private set of investors, into a business, in return for equity in the company.

3. DEPLOYMENT OF CAPITAL–

Can be deployed into:

a) Expanding working capital;

b) Funding new technology;

c) Making acquisitions;

d) Strengthening/Solidifying Balance sheet & Generating profits;

4. PROS OF PRIVATE EQUITY INVESTMENT–

• It stimulates liquidity & entrepreneurship;
• It creates shareholder value;
• It promotes job creation & economic growth;
• It enables investors to invest in world’s leading companies;

5. CONS OF PRIVATE EQUITY INVESTMENT–

• It involves a great deal of risk;
• One of the riskiest investments because many companies fail to perform or underperform;

6. WORKING OF PRIVATE EQUITY FIRMS–

• The primary function of PE firms is to invest in various companies in a specific sector, or spread across multiple sectors;
• A large part of private equity investor’s job is to source out potential companies, perform extensive research on why the company would be a good investment; &
• Finally, implement a plan of action to acquire the company;

II. “VENTURE CAPITAL FUNDING”

1. MEANING–

Venture Capital (here-in-after referred to as “VC” for brevity purposes) Funding refers to a private or institutional investment made into early-stage/start-up companies.

Venture Capital investment is also referred to as risk capital or patient risk capital, as it includes the risk of losing money if venture doesn’t succeed and takes medium to long term period for investments to fructify.

VC typically comes from institutional investors and high net worth individuals and is pooled together by dedicated investment firms.

2. IDEOLOGY–

• VC firms finance innovation and ideas which have high growth potential but with inherent uncertainties.
• This makes it a high-risk, high return investment.
• VC connotes risk finance as well as managerial support.

III. “DIFFERENCE BETWEEN PE & VC” 

• PE firms & Venture Capitalists invest in companies and make money by exiting i.e., generally selling their investments.
• Venture Capitalists invest in start-up funds. Also, VC firms invest small amounts of money in multiple investee companies/firms.
• Whereas, in case of PE firms, the number of investments made in investee companies is smaller, but the investment size of each investment is much larger.
• PE funds are invested in mature companies with a proven track record, where the chances of failure in the near future are lowered.
• PE firms focus on hiring people with IB backgrounds. Whereas VC funds tend to have diverse teams with bankers, consultants, business development professionals and even past entrepreneurs.
• PE firms get highly involved in the functioning of mature companies that they acquire to improve them in the hopes of getting a higher sale price in the future. VC firms meanwhile, work closely with companies early on in their development. VC firms help startups with hiring, partnerships, and back office support, among other things.
• PE funds, operate in a highly structured and often templated way. Their whole model is to invest in a company, improve it and sell it off for a higher price.
• Venture Capitalists typically raise funds and then typically have a cycle of around ten years to put that money out into investee companies/firms and make a return on that investment.
• PE investors typically take controlling interest in mature, performing companies, whereas, Venture capitalists can invest in company at any stage in its development.
• Usually, PE firms will spend hundreds of millions of dollars to acquire a controlling interest in their target company. VCs make smaller, incremental investments in a company slowly over a span of time.
• Venture capitalists often have one or more co-investors in a syndicate whereas PE firms invest on their own.