Private equity firms aggregate money from different sources, including high net worth individuals and firms to invest in private companies that are yet to be listed but have good potential for capital appreciation.
Different Kinds of PE Investing
There are several ways of investing in a private equity portfolio. Some of the typical ones are:
Distressed debt: PE investment firms buy large amounts of debt from a company struggling with its cash flows and profitability and assist it to turn around and become profitable.
Fundraising: Typically, a private equity fund is set up to form an investment fund with capital from limited partners for investment in companies with potential.
Leveraged buyouts: A leveraged buyout or LBO, as it is more commonly known, involves the acquisition of a controlling stake in a company, usually a struggling one but with high growth potential. The PE fund takes an active interest in making the company profitable and in a state where it can repay its debt to the investors.
Real estate: The PE firm deploys its funds contributed by high-net-worth and accredited investors to buy properties. The fund requirement for this class of investments is generally high.
Advantages of Private Equity
There are quite a few advantages that private equity funds bring to the table for companies. For one, they provide a viable route for raising working capital that may be otherwise difficult for the company because it doesn’t have too long a track record for conventional lending institutions to consider. However, private equity firms are not averse to taking greater risks in search of higher returns, observes Fred Auzenne. The PE firms can infuse enough cash for working capital to get the struggling company back on track to sustained profitability. Additionally, the PR investment route means that the company does not have to approach banks and take on the burden of high-interest loans with strict repayment schedules. Any failure to repay the bank loan on schedule will also hurt the credit score of the business. It is likely to affect its ability to raise funds in the future.
Getting funds from PE firms also enables them to try out different growth strategies at an earlier stage. Check out how the private equity waterfall model works and how it might benefit limited partners investing in private equity funds.
Disadvantages of Private Equity
Getting a PE fund to invest in a company is not necessarily a quick affair. The company must be potentially exciting enough to be noticed by the PE firm from the hundreds of investment opportunities available to them. Startups and companies struggling to get into the fast track will need to convince long and hard for a PE form to consider investing in it. Many times, you will go through the entire process only to be disappointed with the outcome of the negotiations. PE firms investing in a company will want an active role in the company management, which may lead to loss of control by the promoters.
Conclusion
PE funding can come in very useful for companies with the potential to grow very fast but are cash strapped. However, the owners of the company have to be ready to part a certain amount of management control besides demonstrating a strong commitment to the company’s continued growth.
