Private Equity Basics

What’s in this section:

 

 

Since Private Equity investing is probably quite new to you, considering that you have been locked out of it for the reasons we described earlier, let’s walk through the basics:

 

What is Private Equity?

 

Private equity is an asset class that consists of equity securities and debt in companies that are not publicly traded (i.e., not listed on the stock market).

Simply stated:

Private equity is an investment in a private company.
 

How does Private Equity compare as an asset class to Public Equity?

PRIVATE EQUITY PUBLIC EQUITY (SHARES)
Less liquid / limited liquidity More liquid / stronger liquidity
Return goal = 2 - 4X on invested capital, not tied to the market Single-digit returns that are tied to the market fluctuations
Longer investment period (typically 3-10 years) Short or long term investment periods
Active involvement (Varies) Minimal active involvement
Low market efficiency Higher market efficiency
No published information Published Information
Lower regulatory oversight Highly regulated

 

An example of a private equity investment, might be:

 

Buying stock in or loaning money to a family-owned restaurant.

 

But private equity is also a BIG business. PE firms manage an estimated $2+ trillion in assets worldwide, with close to $1 trillion in committed capital available to make new PE investments.

Recognize the below companies? They are all examples of private equity investments. Private equity is often established, well-known brands that are generating substantial revenue.

JCrew, BeatsAudio, The Container Store, Dunkin Donuts, Toys R Us, Dominos Pizza, Walgreens, BIOMET, MGM, Petco, The Vitamin Shoppe, Univision

 

Different types of Private Equity

 

Private Equity, Venture Capital, Angel Investing…
What’s the Difference?
 

Seed, angel, and venture capital are, in fact, types of private equity because they provide money to private companies.

Question: What is the key difference between a PE firm and a VC firm?

Answer: While both firms are in the business of providing money (AKA “Capital” in the finance world), the key difference is that PE provides capital only to established businesses (because they don’t want to take on too much risk), whereas VC provides capital to startups.

Angel Investor: Very early-stage funding, often received from an affluent investor (could be a retired investor, executive, or “friends and family” money). This investment is often used to fund research/product development and usually a much smaller dollar amount than would be provided by a VC or PE fund.

Did You Know: The term "angel" originally comes from Broadway, where it was used to describe wealthy individuals who provided money for theatrical productions. (Wikipedia)

Angel Groups: This group of investors is becoming more common - refers to a group of angels that join together to pool their money into an investment and also provide advice to their portfolio companies.

Venture Capital: A venture capitalist provides funding for a startup or early-stage company, usually before the company has become profitable. A VC often invests in unproven, cutting-edge technologies. A VC investment is highly risky, but can be quite lucrative. It’s been known as “spray and pray” money. Everyone wants to invest in the next Facebook, but the vast majority of startups completely fail.

 

  Private Equity Venture Capital Angel Investing
Target Investment Mature companies often under-performing or under-valued Startups, early-stage companies, usually pre-revenue Startups, very early stage, pre-revenue
Target Industry All industries, usually with an established market for the product/service High-growth industries like technology, biomedical, alternative energy All industries
Return on Investment (ROI) Avg returns of 14.7% in the past 5 years 1 The vast majority are failures, with some solid returns, and a few spectacular successes Vast majority are failures, with some solid returns, and a few spectacular successes
Level of Risk Moderate High Very High
Investment Size Traditionally at least $1M... InvestX allows members to invest with as little as $5K Less than $10M Less than $1M
Funding Structure Ownership equity Ownership equity Convertible debt or ownership equity
 

 Sources:

1. Cambridge Associates United States PE/VC Benchmark report, Sep 2015