FBNQuest has described private equity as a type of capital investment made to companies that are not publicly traded on a stock exchange.
It stated this in a report on ‘Understanding private equity and alternative investments – FBNQuest’
Part of the report read, “Private equity is a type of capital investment (asset or security) made to (target) companies that are not publicly traded on a stock exchange.
“As an alternative form of private financing, private equity allows investors directly invest in companies through which such investors gain an ownership stake in the companies.
“Investors seek PE funds to earn returns that are considered to be better than those from the public equity markets.”
Although there are a variety of options for raising capital and attracting investors, it explained that equity is one of the two most sought-after options.
It allows a company to give a share of ownership of its business to an investor in expectation of a return as the business grows, it stated.
FBNQuest explained that unlike public equity (stock market) with ownership of shares in a public company, private equity simply means ownership of shares in a private company.
To avoid debt, a company could sell its stocks to raise money that could be used to fund new technology, make acquisitions, expand working capital, and fund projects geared towards business growth.
Usually, it added, the financial information on stocks of such a company was not disclosed to the public, rather an investor could only speculate on the asset worth of the intending company.
It said, “Private equity involves three parties: the investors who supply the capital, the private equity firm that manages and invests the money on behalf of the investor via a private equity fund, and the company (known as portfolio company) that the private equity firm invests in.
“A private equity firm’s ultimate goal is to sell or exit portfolio companies to deliver superior returns (above the benchmark return also referred to as Internal Rate of Return to earn carried interests).”
According to the report, the most widely adopted investment strategies by PE investments are Leveraged Buyouts and Venture Capital investments.
It stated, “In LBOs, a PE firm will raise debt from institutional investors on the back of a target company and assume control of the target company, while using the cashflows of the target company to pay the acquisition capital.
“Whereas, the VC makes investment in young and fast-growing companies in an industry that has the potential for exponential growth while adding value to the firm being taken up.
“In some cases, PE firms grow and improve a middle-market company with the aim to sell or exit to a mature company within a specified period.”
Generally, it added, private equity firms were active investors who were involved in the board level and monitored the financial and operating performance of portfolio companies.
However, some private equity firms were involved in the day-to-day operations of portfolio companies and may take C-level positions such as chief executive officers, chief finance officers, and chief operating officer to ensure that value creation initiatives were implemented in the portfolio companies to ensure increase in revenue, improvement of operational efficiency and corporate governance.