BREAKING DOWN PRIVATE EQUITY AND ITS FORMS
Private equity refers to an alternative investment class that’s made up of capital not publicly listed. Basically, these are funds and investors that directly invest in private companies, or those that participate in the buyout of public companies, which results to their delisting.
Private equity investments come from institutional and accredited investors, who can dedicate substantial sums of money for extended spans of time. In the majority of cases, considerably with long holding periods are usually needed for private equity investment to ensure a turnaround for distressed companies to enable liquidity events like IPOs or a sale to a public company.
Most Common Types of Private Equity Funding
In this type of funding, the money is funneled to a company with struggling business units or assets, with the goal of turning them around. They:
Change the business’s management
Restructure the operations
Sell assets (physical machinery, real estate, intellectual properties, etc.)
This type of financing is also known as ‘vulture funding’ simply because the most likely candidates are companies that have filed under Chapter 11 bankruptcy.
The most popular form of private equity funding, this process involves the complete buyout of the company to improve its business and financial health and then reselling it to interested parties via an initial public offering (IPO).
This also involves different kinds of strategy, from slashing down the number of employees to completely changing the management.
Initially, a private equity firm finds a candidate and makes special purpose vehicle (SPV) to fund he buyout. A combination of debt and equity is usually used to finance the transaction, with debt accounting for as much as 90 percent of the fund. The debt financing is then transferred to the acquired company to get some tax benefits.
Real Estate Private Equity
After the chaotic 2008 financial crisis obliterated real estate prices, this type of funding saw a massive increase in number.
The common items where funds are funneled include real estate investment trusts and commercial real estate.
These funds require higher minimum capital for investments when compared to other private equity funding.
Funds of funds
As the name suggests, this type of funding targets other funds, usually mutual and hedge funds. Funds of funds help investors who cannot afford the minimum capital requirements of those two funds.
However, there are critics who point out that funds of funds’ higher management fees and too funds diversification many not always lead to an optimal strategy to increase returns.
Venture capital funds are where “angels,” which provide capital to entrepreneurs, are found. Venture capital funds can be different forms, depending on the stage they are provided.
Seed financing, for instance, refers to the capital given by investors to scale an idea from a prototype to a real product or service. Meanwhile, early stage financing can aid an entrepreneur develop a company further. Series A financing lets them actively compete in a market.
Private equity firms earn money primarily through management fees. There are different fee structures for different private equities, although the most common fees are management fees and performance fees.