The three most common private equity strategies are venture capital, growth equity, and buyouts. These strategies are not in conflict with one another and need different skills, but they all play a role in an organization’s life cycle. Here’s a breakdown of each private equity approach so you can put together a complete portfolio.
- VC (Venture Capital)
A venture capital (VC) investment is a private equity investment made in a startup that is still in its early stages. In exchange for a portion of the firm, venture capitalists provide a specified seed investment. Typically, venture funders do not seek a majority stake (more than 50%), which can be appealing to founders, according to Joseph Stone Capital.
Because startups haven’t shown their potential to produce a profit, venture capital investing is inherently hazardous. Venture capital’s return on investment is never guaranteed, as it is with any other investment. However, if a startup proves to be the next big thing, venture capitalists stand to make millions, if not billions of dollars.
- Growth equity
Growth equity is a private equity strategy that involves investing in an established, growing company. Growth equity is used later in a company’s lifespan when it has established itself but requires additional money to expand. Growth equity investments, like venture capital, are made in exchange for firm equity, usually a minority part. Unlike venture capitalists, growth equity investors can look into a company’s financial history, meet customers, and test the product before deciding if it’s a good investment. Any investment has risk, but with growth equity, the company has the opportunity to demonstrate that it can generate a profit before the private equity firm participates, according to Joseph Stone Capital.
Many growth equity firms keep a database of up-and-coming businesses and track their financial data over time, often for as long as ten or fifteen years. That helps companies to identify organizations that are generating money and increasing rapidly. Then approach them when they appear to require funding to continue expanding. A keen eye for a great founder or team, as well as thorough, measured research and financial analysis and forecast, are all required for successful growth equity investing.
Buyouts are the last private equity technique that occurs later in a company’s life cycle. A buyout happens when a mature, usually publicly-traded company is taken private and purchased by either a private equity firm or the company’s current management team. In the private equity industry, this sort of investment accounts for the funds.
When a company gets bought out, all of the former investors cash out and leave. The private equity firm or management team becomes the sole investor in the company and must own a controlling stake (more than 50 percent).
There are two sorts of buyouts.
- Management buyouts, the company’s assets get purchased, and the existing management team gains control.
- Buyouts that get financed using borrowed funds are known as leveraged buyouts.