Private equity refers to the ownership in a private corporation: a company which is not publicly traded. However, the phrase ‘private equity’ has evolved to more specifically refer to the act of investing capital in companies who do not trade on the public markets or conducting buy-outs of public companies – the end result being that they are de-listed from the stock exchange.
Private equity is not simply a financing method. It is a massive part of the finance industry, and private equity companies – those investment vehicles specialising in these kinds of deals – have stakes in well known brands like Formula One, Domestic & General and Crocs. There are a range of investment strategies and financial structuring options associated with private equity. These include: LBOs, venture capital, growth capital, distressed securities and mezzanine capital amongst others.
Unlike venture capital, where a fund may look to make investments in smaller companies with growth potential, a private equity fund often looks to invest in more mature companies which may even be under-performing… but are ripe for turnaround potential.
Perhaps the most common kind of deal associated with private equity is the leveraged buy-out or LBO. The LBO came to prominence in the 80′s when financiers like Henry Kravis would buy up shares in a target company using capital acquired from issuing junk bonds. After they had gained control of the company, they would saddle the company with the debt they raised and look to find ways to create greater shareholder value, with themselves now the majority owners. In an LBO, the acquirer uses their target’s assets as collateral to raise debt to buy shares in the target and leverage their position. Once the takeover is completed, they transfer the debt to the target’s balance sheet and try to identify cost saving measures and new business opportunities, which increase the value of the firm. Some corporate raiders have taken LBOs to the extreme, taking over companies with suppressed share prices and then selling off the individual assets of the company to pay off debt they used to fund the take over, hopefully generating a lot of cash and leaving something resembling a business behind at the end, a process known as asset stripping.
Whatever the private equity firm’s strategy, if it can not add any more value to the acquisition or it discovers a better place to allocate capital, it will seek an exit route, and in doing so should realize a tidy profit.
Listed below are some of the most common exit strategies in private equity:
• Sale to industry
• Secondary buy-out
• Leveraged recapitalization
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