Private equity (PE) is money invested into companies that are not publicly traded. Public companies are companies that have equity structured as shares of stock. These companies are traded on a stock exchange after an initial public offering (IPO). The term also refers to the fund strategies investors use to make money from their investments.
Private equity investments offer a broad range of opportunities. Investors can invest in promising startups or revitalize a struggling brand. Private equity appeals to investors looking to earn better returns than what can be achieved through investing in stocks.
Read on to find out more about private equity investing and its key investment strategies.
9 Types of Private Equity
Private equity funds are considered "alternative" investing opportunities compared to buying stocks or real estate properties and other assets that have long-term growth potential. Learn more about the nine types of private equity funds below.
1. Leveraged Buyout (LBO)
A leveraged buyout fund strategy combines investment funds with borrowed money. The purpose of the fund is to buy companies and make them profitable. By combining the borrowed money with the investor's money, the fund manager has more capital to buy larger companies. In these types of deals, companies are either purchased outright or the buying company takes a majority stake in the business to control its strategies and direction.
It's called leveraged buyout because the buying company leverages creditors' and investors' money to afford larger buyouts. In return, the larger buyouts could mean larger returns for investors if the strategies pay off.
2. Venture Capital (VC)
Venture capital is a form of private equity and financing that deals with funding early-stage startups and new businesses. Venture capitalists invest in companies that they believe have high growth potential. They also fund startup companies that have grown quickly and are set up for more expansion.
Unlike leveraged buyout funds, venture capital funds generally take a minority stake. This leaves the control of the business in the hands of company management. In a way, venture capital investing is a riskier strategy because the companies are new and have no track record of making money.
Venture capital firms generally create and manage this type of funding. The investment typically comes from well-off investors, investment banks, angel investors, and other financial institutions. Sometimes, investors don't always contribute money. Offers of technical or managerial expertise are also accepted.
There are many stories of venture capital investment that had high returns. One example is Sequoia Capital's $60 million investment in WhatsApp, which turned into at least $3 billion when Facebook acquired the company in 2014. Although Sequoia's story is not the norm, it's what attracts investors to venture capitalism.
3. Growth Equity
Companies raise capital through growth equity to boost expansion. Growth equity, also known as growth capital or expansion equity, works similarly to venture capital but it's less speculative. The firms will do their due diligence to make sure the companies receiving the investment are already profitable, have higher valuation, and little to no debt.
Growth capital invests in mature companies looking to grow their business by entering new markets or buying other companies. Typically, growth equity deals dole out minority ownership to investors in the form of preferred shares. This type of funding still allows investors to make high returns but with medium risk.
4. Real Estate Private Equity (REPE)
Real estate private equity funds invest in properties using different strategies. Some funds are conservatively invested in low-risk rental properties offering stable, predictable income. Other funds invest in land or speculative development deals, which offer high return potential and greater risk.
Real estate PE firms manage this type of fund. They raise capital from outside investors called limited partners (LPs). The investments are used to buy, develop, and operate properties. The firms will also improve real estate investments to be sold for profit. Most funds focus on commercial real estate and generally only operate rental residential real estate.
Infrastructure private equity works similarly to real estate equity. Firms raise capital from private equity investors. Then, they use that capital to buy assets, operate them, and eventually sell them for profit. The difference with infrastructure funds is that they invest in assets that provide essential utilities or services. This includes sectors like:
- Utilities (e.g., gas, electricity, water)
- Transportation (e.g., airports, roads, bridges, rail transit)
- Social infrastructure (e.g., hospitals, schools)
- Energy (e.g., power plants, pipelines)
- Renewable energy (e.g., solar power plants, wind farms)
Infrastructure businesses are stable and generally operate for decades. Some businesses, like airports and utility companies, have monopolies in their services, which makes them incredibly valuable. All of which makes infrastructure investing relatively low risk.
6. Fund of Funds
A private equity fund of funds raises capital from investors but doesn't invest in private companies or assets. Instead, it acts as an investor and buys into a portfolio of other private equity funds. For example, a fund of funds firm will invest in a real estate private equity firm, a venture capital company, or a leveraged buyout fund. Professional investors manage the fund and charge a management fee.
With this type of fund, investors achieve the benefit of diversification. It also provides access to funds individual investors might not otherwise have been able to invest in. Since fund of funds moves in all private equity circles, it also affords its investors entry to niche funds that offer higher returns. Generally, fund of funds investors are pension funds, accredited investors, endowments, and high-net-worth individuals.
7. Mezzanine Capital
The mezzanine floor of a building is halfway between one floor and another. Hence, this type of fund is aptly named because mezzanine capital is halfway between debt financing and raising equity capital. Companies typically use it to raise funds for specific projects.
Mezzanine capital is issued to investors in the form of preferred stocks or subordinated notes. A subordinated note is an unsecured debt security that earns higher interest rates. In the order of who gets paid first, it sits above preferred and common stock but below creditors. This type of private equity is a hybrid form of financing that aims to earn a higher rate of return than debt and carry a lower risk than equity financing.
8. Distressed Private Equity
Distressed private equity funds, also known as special situations, specialize in lending to companies in financial crises. When the funds invest in companies, their purpose is to take control of the business during the bankruptcy or restructuring processes so they can buy the company at a lower purchase price. Then, they'll work to turn the companies around and, eventually, sell them. Sometimes, they'll even take the company to the public markets and be listed on a stock exchange.
Like most firms in this list, distressed private equity firms also raise capital from outside investors, hold the investment for long periods, and use it to buy assets or companies. Distressed PE funds investors include hedge funds, institutional investors, and high-net-worth individuals.
Secondaries funds sometimes buy companies or assets and invest in other private equity funds portfolios, but that's not the primary use. Instead, the secondary market exists to buy investments committed in a fund.
Going back to the beginning, most of the private equity funds included in this list are typically organized as limited partnerships. Investors represent the limited partners and would need to commit capital throughout a fundraising process. The fund's management team members are called general partners.
A typical private equity fund has an initial duration of 10 to 12 years. The first five years are called an investment period. The years after that are the harvesting period, during which investors can sell their investments.
If an investment hasn't reached the harvesting period but an investor needs or wants to take their money out, the only way to do that is to sell through the secondary market.
Let Skynova Help You Manage Your Small Business Equity
Private equity funds are considered "alternative" investing opportunities instead of traditional long-term investments in stocks, real estate properties, or other assets. Private equity funds could be right for you if you're trying to raise capital for your business or looking for investment opportunities to diversify your income.
For your business, calculate and track your owner's equity with Skynova's accounting software. Generate financial statements, such as balance sheets, income statements, and cash flow statements, whenever you need them. Having current and reliable information gives you a real insight into your business's value and ongoing profitability. Knowing how your business is doing helps you make better-informed decisions in running and growing your business.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always do more research and consult with a professional to ensure that you're making the best decisions for your business.