Private equity investment is defined as taking equity stakes in unlisted companies in order to finance start-ups, growth plans and buyouts. Private equity investors take equity interests (with no guarantees) with a view to realising a capital gain upon exit.
Their investment is primarily financial, but it may also include a strategic investment, such as a contribution of know-how or the use of a network.
Private equity practices
Private equity entails investing at different stages in the life of a company: start-up, growth, crises, acquisition and buyout. Four types of private equity investment are generally identified:
- Venture capital
- Growth capital
- Buyout capital
- Turnaround financing.
This type of private equity investment always gives the investors a say in the management and strategy of the target company. The equity stake comes with voting rights at general meetings.
This type of investment mainly involves young innovative companies seeking financing, primarily in the technology and life sciences sectors.
This type of investment breaks down into:
- Seed money, used to finance research and the preliminary development of a concept. This financing is provided when a product or service is first being developed. This stage can show if a project is feasible, before it reaches the marketing stage.
- Start-up capital, which is used to finance start-up companies during the development and preliminary marketing of their products. Target companies are less than three years old and have yet to turn a profit.
Growth capital is invested in more mature companies after the start-up period. The targets are more than three years old and show a profit. Growth capital is used to consolidate the company’s financial structure for the next stage of its growth, including acquisitions or the development of new product ranges, for example.
Growth capital investment is not specific to certain business sectors, unlike venture capital, which usually focuses on new technologies. Furthermore, growth capital is usually used to acquire minority investments.
Buyout capital easily accounts for the largest share of private equity investment. It is used to finance the acquisition of a company, either by its managers or by outside investors. Buyout transactions are often leveraged, which means the acquisition is paid for with borrowed money. This is the origin of the term “leveraged buyout”, or LBO.
Turnaround financing is invested, for example, when a company is in crisis and needs restructuring. Investors may inject capital into the company to enable it to overcome its difficulties.
Exit or divestment
Private equity investors are supposed to pull out of the target company in the short to medium term. Since the securities involved are not traded on a regulated market, exits are a delicate matter. Investors can make several types of exit:
- The best known is an initial public offering (IPO) of the target company’s shares. This type of solution, however, cannot be envisaged unless the regulated market has a special segment for small companies.
- The most common exit is through a trade sale to a company in the same sector.
- A third exit solution is a sale to another investor through an investment fund or a secondary LBO, for example.
- The other exit solution is to sell the company to its management team.