tions, management, or ownership.
Bloomberg Business week
has called private equity a rebranding of leveraged buyout firms after the
1980s. Among the most common investment strategies in private equity are:
leveraged buyouts, venture capital, growth capital, distressed investments and
mezzanine capital. In a typical leveraged buyout transaction, a private equity
firm buys majority control of an existing or mature firm. This is distinct from
a venture capital or growth capital investment, in which the investors
(typically venture capital firms or angel investors) invest in young or
emerging companies, and rarely obtain majority control.
Private equity is also
often grouped into a broader category called private capital, generally used to
describe capital supporting any long-term, illiquid investment strategy.
* Growth Capital :-
Growth Capital refers
to equity investments, most often minority investments, in relatively mature
companies that are looking for capital to expand or restructure operations,
enter new markets or finance a major acquisition without a change of control of
the business.
Companies that
seek growth capital will often do so in order to finance a transformational
event in their life cycle. These companies are likely to be more mature than
venture capital funded companies, able to generate revenue and operating
profits but unable to generate sufficient cash to fund major expansions,
acquisitions or other investments. Because of this lack of scale these
companies generally can find few alternative conduits to secure capital for growth,
so access to growth equity can be critical
to pursue necessary facility
expansion, sales and marketing initiatives, equipment purchases, and new
product development. The primary owner of the company may not be willing to
take the financial risk alone. By selling part of the company to private
equity, the owner can take out some value and share the risk of growth with
partners. Capital can also be used to
effect a restructuring of a company's balance sheet, particularly to reduce the
amount of leverage (or debt) the company has on its balance sheet. A Private
investment in public equity, or PIPEs, refers to a form of growth capital
investment made into a publicly traded company. PIPE investments are typically
made in the form of a convertible or preferred security that is unregistered
for a certain period of time. The Registered Direct, or RD, is another common
financing vehicle used for growth capital. A registered directs is similar to a
PIPE but is instead sold as a registered security.
* Mezzanine Capital :-
Mezzanine capital
refers to subordinated debt or preferred equity securities that often represent
the most junior portion of a company's capital structure that is senior to the
company's common equity. This form of financing is often used by private equity
investors to reduce the amount of equity capital required to finance a
leveraged buyout or major expansion. Mezzanine capital, which is often used by
smaller companies that are unable to access the high yield market, allows such
companies to borrow additional capital beyond the levels that traditional
lenders are willing to provide through bank loans. In compensation for the
increased risk, mezzanine debt holders require a higher return for their
investment than secured or other more senior lenders. Mezzanine securities are
often structured with a current income coupon.
* Private equity in the 1980s :-
In January 1982,
former United States Secretary of the Treasury William Simon and a group of
investors acquired Gibson Greetings, a producer of greeting cards, for $80
million, of which only $1 million was rumored to have been contributed by the
investors. By mid-1983, just sixteen months after the original deal, Gibson
completed a $290 million IPO and Simon made approximately $66 million.
The success of the
Gibson Greetings investment attracted the attention of the wider media to the
nascent boom in leveraged buyouts. Between 1979 and 1989, it was estimated that
there were over 2,000 leveraged buyouts valued in excess of $250 million.
During the 1980s,
constituencies within acquired companies and the media ascribed the
"corporate raid" label to many private equity investments,
particularly those that featured a hostile takeover of the company, perceived
asset stripping, major layoffs or other significant corporate restructuring
activities. Among the most notable investors to be labeled corporate raiders in
the 1980s included Carl Icahn, Victor Posner, Nelson Peltz, Robert M. Bass, T.
Boone Pickens, Harold Clark Simmons, Kirk Kerkorian, Sir James Goldsmith, Saul
Steinberg and Asher Edelman. Carl Icahn developed a reputation as a ruthless
corporate raider after his hostile takeover of TWA in 1985. Many of the
corporate raiders were onetime clients of Michael Milken, whose investment
banking firm, Drexel Burnham Lambert helped raise blind pools of capital with
which corporate raiders could make a legitimate attempt to take over a company
and provided high-yield debt ("junk bonds") financing of the buyouts.
* Investments In Private Equity :-
Although the
capital for private equity originally came from individual investors or
corporations, in the 1970s, private equity became an asset class in which
various institutional investors allocated capital in the hopes of achieving
risk adjusted returns that exceed those possible in the public equity markets.
In the 1980s, insurers were major private equity investors. Later, public
pension funds and university and other endowments became more significant
sources of capital. For most institutional investors, private equity
investments are made as part of a broad asset allocation that includes
traditional assets (e.g., public equity and bonds) and other alternative assets
(e.g., hedge funds, real estate, commodities).
Most institutional
investors do not invest directly in privately held companies, lacking the expertise
and resources necessary to structure and monitor the investment. Instead,
institutional investors will invest indirectly through a private equity fund.
Certain institutional investors have the scale necessary to develop a
diversified portfolio of private equity funds themselves, while others will
invest through a fund of funds to allow a portfolio more diversified than one a
single investor could construct.
Returns on private
equity investments are created through one or a combination of three factors
that include: debt repayment or cash accumulation through cash flows from
operations, operational improvements that increase earnings over the life of
the investment and multiple expansions, selling the business for a higher
multiple of earnings than was originally paid. A key component of private
equity as an asset class for institutional investors is that investments are
typically realized after some period of time, which will vary depending on the
investment strategy. Private equity investments are typically realized through
one of the following avenues:
- an Initial Public Offering (IPO) – shares of the company are offered to the public, typically providing a partial immediate realization to the financial sponsor as well as a public market into which it can later sell additional shares;
- a merger or acquisition – the company is sold for either cash or shares in another company;
- a Recapitalization – cash is distributed to the shareholders (in this case the financial sponsor) and its private equity funds either from cash flow generated by the company or through raising debt or other securities to fund the distribution.
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