Private equity is a kind of equity investment in an asset that cannot be traded freely on the stock market. Private equity is of many kinds, including mezzanine capital, angel investing, leveraged buyout, venture capital etc.
Private Equity: How it Works
Private equity funds are set up as limited partnerships. These limited partnerships are controlled by private equity companies that are the general partner in the limited partnership. The private equity company encourages individuals and institutions to invest in the private equity fund. This way, the investors become limited partners, though the general partner controls the company management. When the general partner thinks that a particular investment is feasible, it asks the limited partner to invest the amount it guaranteed. The general partner chooses the investment portfolio of the partnership, while the limited partner provides funds for investing. The limited partner, or investor, in turn profits through sales, mergers, recapitalization or initial public offering.
Categories of Private Equity:
Private equity has many kinds of investments that fall under it, but the major ones include growth capital, angel investing, venture capital and leveraged buyout.
Advantages of Private Equity Funds:
1) Funds gotten through private equity are crucial for the growth of industry and the development of innovative products.
2) Private equity funds are used for expanding working capital.
3) Private equity funds are helpful when it comes to facilitating mergers and acquisitions.
4) Private equity funds make a company’s balance sheet stronger, and help it develop.
5) Private equity funds are a great way to obtain funds for small businesses and start-ups that have not been able to get loans or grants.
6) The general partner runs the company, so the investing partner, or the limited partner, cannot interfere in the management of the company.
Disadvantages of Private Equity Funds:
Apart from advantages, private equity funds have certain drawbacks.
1) Since private equity funds are not open to investment on the stock market, anybody who wants to sell stocks of a private equity fund finds it difficult to locate a buyer.
2) There are certain transfer limits on private equity.
3) Most individuals cannot afford the high investments required in a private equity.
Private equity funds are an excellent investment options for venture capitals and other organizations looking for long-term investment in projects that will bring in good returns. However, they are not open for public trading and not affordable to minor investors and individuals. Forming a private equity fund is a good option for small business owners who have not been able to source funds for their start-ups or long running business from any other source.