Private Equity

Question & Answer

What is private equity?

Private equity generally refers to an equity investment in a company that is not listed on a stock exchange. Therefore, the purchase and sale of shares is privately negotiated. Obtaining private equity is very different from raising debt, in that the investment is made in exchange for ownership whereas traditional debt has no equity stake in a company and is simply paid back over time, generally with interest.

Is venture capital the same thing as private equity?

Venture capital is a category of private equity investments. Venture capital firms generally invest in early stage businesses and take a partial ownership position in those businesses. It may be generally said that venture capital firms are willing to take technology, product or concept risk while other private equity firms will only invest in more mature, established companies.

What are some types of private equity investments?

  • Early- and mid-stage investments - current shareholders retain ownership in their company while issuing new shares to investors. The capital is used to finance expansion, among other things.
  • Buy-outs (acquisitions) - the sale of a significant portion or all of a company's equity. While strategic buyers or competitors may acquire a business, private equity firms are also a large source of acquisition capital.
  • Recapitalization - owners can recapitalize their business, allowing them to sell a significant stake in a business while retaining their operating involvement. This can be accomplished by taking on debt to repurchase some of the equity, or by bringing in a private equity firm to purchase some of the equity and help with organizing the debt financing associated with such a transaction.

How do private equity firms value companies?

Private equity firms generally value companies based on the future returns that the business can generate; the methodology will generally vary based on the stage of the company. For an early stage company, this will often be based on future growth and earnings prospects for the business. For a later stage, more mature business, the valuation is generally based on a multiple of cash flow. A commonly-used proxy for cash flow is EBITDA which stands for "earnings before interest, taxes, depreciation and amortization." Multiples differ based on industry trends, size of company, history, growth potential and more.

Public company multiples provide valuable data points for understanding the value of a comparable private company; however, private company multiples are typically lower than public company multiples because of the lack of liquidity in a private company. Additionally, there are size discounts; larger companies generally have higher multiples than smaller companies.

How long is the funding process and what might it look like?

Generally, it takes two to six months to go from introduction to closing a deal. In the first stages, the business and private equity firm are getting to know each other. The private equity firm is learning about the business and the market, while the business owners are researching the private equity firm to ensure that it is an appropriate long term partner. If a private equity firm is interested, it will request additional information and move towards submitting a Letter of Intent or Term Sheet which outlines the terms of a potential deal, the basis for initial negotiations. This will include valuation and other basic terms of an agreement, prior to coming to a definitive agreement. Firms generally expect exclusivity after coming to a Letter of Intent.

Due diligence can be a long and detailed process and entails a thorough collection of information and review of all aspects of the business. While much of this is confirmatory due diligence, the process allows the company and firm to continue getting to know each other while ensuring that the firm can know as much about the company and opportunity as possible, in advance of an investment.

What is the role of private equity in a down economy?

In a down economy, companies may have difficulty accessing debt to fund operations or growth. If debt is available, it may be at a higher cost or come with additional restrictions than would otherwise be required. Private equity firms will continue to have readily available capital meaning that private equity is a viable capital source even in challenging economic environments.

How can private equity help business owners?

Private equity has many uses to entrepreneurs, managers and business owners. It can allow for:

  • Owners to realize some liquidity by selling part of their equity
  • Shareholders to sell all of their equity interests by being acquired outright
  • Companies to raise capital to fund expansion and operating capital needs
  • Partial or complete management buy-outs
In the end, companies and their owners have numerous options when it comes to funding their business and managing the value of their ownership.