Many entrepreneurs who are looking to break into the business market have likely heard about private equity funding. As with many elements related to business and startups, just because one has heard of something, doesn’t necessarily mean they understand what it is and how it works. Frankly, there are so many different lending options out there for small business and business startups that it could easily be confusing as to which ones are right for your needs.
The history of modern private equity investments goes back hundreds of years; however, the frequent use of private equity did not gain prominence until the late 1980s. That is around the time when technology here in the United States got a much-needed boost from venture capital investors. Many fledgling or struggling companies were able to utilize private sources as a source of fundraising rather than going to the public market. Some of these struggling companies are easily recognizable such as Apple. That Mac you are using to read this article or your iPhone sitting on your desk is the result of the strategic use of private equity over traditional funding.
If you are a budding entrepreneur or a small business who is struggling to secure funding, you may be considering private equity funding. Before exploring this option, it may help you to read a bit further. Below we have broken down some of the details around private equity funding and how this form of funding differs from traditional public bank funding such as banks. The information below will help you to understand the basics of private equity and how it may be helpful to you in reaching your business goals.
What is Private Equity Funding?
Private equity funding are pools of capital that are to be invested in companies that represent an opportunity for a high rate of return for the investors. Private equity funds are not forever. These funds have a fixed investment horizon, meaning at some point in the future, the private equity firm will no longer fund the investment. This period is typically between four and seven years from the initial date of investing. At this point, the private equity firm hopes to exit from the investment in a profitable manner. There are several different exit strategies an equity firm may use. Those are described below.
Private equity funds are considered an alternative investment class or option. Because private equity funds are private, their capital is not listed on a public exchange. The money used to invest in your startup comes from the investments of those with a high net worth into the pool of funds used for investment funding. Eventually, these investors hope to see a return on their investment when the private equity firm exits the investment. Generally, these high net worth investors consist of institutional funds and accredited investors who can provide substantial capital for extended periods of time. A team of professionals from a particular private equity firm such as The Venture North Group is responsible for raising and managing the funds invested.
How Private Equity Funding Works
Private equity funds are set up as a limited partnership by a private equity firm. The firm then reaches out to large investors to raise capital. These investors can include university endowments, charities, insurance companies, and wealthy individuals, among others. Once invested, the limited partners’ capital is secured for a predetermined number of years before the fund is eventually liquidated, and the principal (the amount initially invested) and hopefully profits are returned to the shareholders (the original investors).
Types of Private Equity Funds
Private equity funds generally fall into two different categories. These include venture capital and buyout or leveraged buyout.
1) Venture Capital
Venture capital funds are pools of capital generally managed by a venture capital firm. These funds (or capital) are typically invested in small, early-stage and emerging businesses. The businesses selected for investment opportunities are those that are expected to have high grown potential but likely limited access to other forms of capital. For small startups with ambitious ideas, venture capital funds are an essential source for fundraising capital. These small entrepreneurial startups generally do not meet the long list of requirements for funding, which are typically put forth by traditional business lending institutions such as banks or credit funding companies.
Additionally, these businesses turn to venture capital as they lack access to large amounts of assets and debt, which are also generally required as collateral to secure traditional business loans. For investors, venture capital funds are not without risk. Investing in emerging and unconfirmed businesses can be a significant investment risk but can also generate an exceptional return on investment.
2) Buyout or Leveraged Buyout
These are essentially the opposite of venture capital funds. Buyout or leveraged buyout funds invest in more mature businesses as opposed to emerging startups. During the buyout or leveraged buyout process, a controlling interest in the company is generally acquired. Leveraged buyout funds use extensive amounts of leverage to enhance the rate of return for investors. These types of private equity funding also tend to be significantly larger in size than the investments provided by venture capital funds.
Exit Considerations and Strategies
As noted above, private equity funding is a closed term form of funding. After a predetermined number of years, the private equity firm will begin to explore various exit strategies. Several factors come into play and affect the exit strategy of a private equity fund. Here are some of the considerations that must be examined.
- How long is the investment term (investment horizon), and when does the exit need to occur?
- Is the management team ready and prepared for an exit?
- What are the various exit routes available for the private equity firm?
- What internal rate of return will be achieved?
- Is the current capital structure of the business appropriate and adequate for exit to take place?
Typical Exit Routes for Private Equity Investors
When the private equity firm has decided to exit, they will generally take one of two paths. These include either a total exit or a partial exit. If they choose a total exit, this may result in a trade sale of the business to another buyer, a leveraged buyout to another private equity firm, or a share repurchase.
If a partial exit is chosen, there could be a private placement of the business. This occurs when another investor purchases a piece of the business, and the private equity firm maintains control over the remaining portion. Another possibility for a partial exit is corporate restructuring. This occurs when external investors get involved and increase their position within the business by partially acquiring the private equity firms stake. Finally, there is corporate venturing. This is what happens when the management of the business increases its ownership in the business as the private equity firm partially exits.
If you are an entrepreneur or an emerging small business is located in the Anchorage, Alaska area, we at The Venture North Group would like to work with you to help secure the private equity funding your business needs to get started. Our combined years of expertise in markets worldwide have resulted in relationships with many potential investors. This allows us the ability to help you find the equity funding, which best suits your business needs and goals. If you are ready to take that next step but have struggled with traditional business funding, give The Venture North Group a call.