The definition of Private Equity (PE) is not clear for everyone. Usually, the term PE is used to describe all investments made in “private companies,” e.g., those that are not listed on the stock exchange and are not subject to special financial regulations of the stock market. On the other hand, the PE is the entity’s name that engages and carries out the investments mentioned above in enterprises to obtain capital gains. A specific form of Private Equity is Venture Capital, which includes investments in innovative ventures and companies at very early stages of development, which is also usually associated with high investment risk.
PE funds invest mainly in mature and developing enterprises that plan to enter the stock exchange in the future, require restructuring or change owners. Startups that are just starting their operating activities or only have a project and a business plan are financed less frequently. The movement of investment funds has ended and is an exit based on the sale of the company to another investor or its introduction to the stock exchange. The goal of every PE investor (PEI) is to achieve an IPO, which means the first public offering of their shares on the stock exchange.
Six stages of the company’s life cycle
Depending on the company’s life cycle stage in which the firm is currently located, different financial and brand-building needs to develop. The task of Private Equity and Venture Capital funds is to provide the business with funds that will allow it to move to the next stage of the development process. These are:
Development Stage => Seed financing
The company’s life cycle begins with the development phase. During this stage, the entrepreneur creates and develops his business idea to create a patent that can be turned into a product. It is often associated with PE financing research and development works that require significant capital expenditure, with the current lack of visible capital gain. Investment funds are very reluctant to finance this stage of project development.
Startup Stage => Startup financing
This phase includes an investment in a company that wants to buy fixed assets and current assets to start the entrepreneurial activity. It occurs when the entrepreneur has an idea, business plan, and project but does not have the capital to implement it.
Early Growth Stage => Early Growth Financing
It occurs when the company has already started generating profits. Still, to survive and keep the gap between cash flow and capital needed, it needs more money, which the bank cannot provide due to the very high risk of investment.
Expansion Stage => Expansion Financing
During this phase, the PE is dealing with a growing company. The company’s development can take place in two ways: internal and external. The first one includes investments in new fixed assets and the restocking of current assets. The second, in turn, concerns entering new markets or expanding the area of entrepreneurial activity.
Mature Stage => Replacement Financing
When the sales are stabilized, we can say about the maturity of the company. The role of the fund at this stage is to replace an existing shareholder through a leveraged buyout, investment in a listed company, or restructuring of the company.
Decline Stage => Vulture Financing
A situation when the company falls but still operates and conducts its operations in Private Equity can help the company pay off its debts or purchase new fixed assets to increase the possibilities to multiply revenues.
In a situation where the company has obtained external financing from an entity in the form of PE, it receives a kind of confirmation that its activity is at a very high level. For this reason, the company can use its investors to promote its values, profiles, and reputation across the market. Certification can help a company wh entering new markets as well. This case demonstrates that the company has an excellent reputation, as evidenced by the capital invested in the company.
Every time a PE investor invests in a company, private equity gives the company strong support in its social network while multiplying interactions with new suppliers and recipients. It is crucial for companies in the early stages of development or wanting to accelerate scaling their business. The PE can also provide the venture-backed company with talents that are lacking. They are usually experts who help, e.g., in launching online distribution, securing a contract, or satisfying other necessary needs in the company. It also happens that some Private Equity organizations organize annual events where CEOs and leaders can share their best practices.
The third benefit that a PE investor brings to the company by becoming a company shareholder is knowledge. These can be both “soft” skills: the ability to manage a team, the ability to run a company, negotiate with other players, but also “hard” knowledge – related to the understanding of the industry, specialist knowledge in a given field. By sharing its baggage with an entrepreneur, PEI often acts as an advisor and mentor, making critical strategic decisions for the company, e.g., regarding mergers or acquisitions. Unlike other investors or lenders, PE funds are much more involved in helping you analyze every aspect of your business to see how you can maximize its value. It can also be associated with numerous problems if their idea of maximizing value does not fit the founder’s idea, but having experienced professionals involved in business development can also significantly improve.
The most significant value provided to the company by Private Equity and Venture Capital is money. Some investments can reach hundreds of millions of dollars, so the impact on the development of the enterprise with such financing can be huge. In 2009, Delaware City Refinery had to close its main refinery and lay off the vast majority of its employees. A year later, Blackstone’s private equity firm invested $ 450 million in the company, enabling it to open its main refinery and re-hire over 500 employees.
Combining the acquired capital, expertise, and knowledge of PEI can rapidly impact the business and ensure its dynamic development. A 2012 study conducted by The Boston Consulting Group found that more than two-thirds of private equity deals increased the company’s annual profit by at least 20%, and nearly half of the sales generated an annual profit growth of 50% or more.
The decision to obtain equity financing from Private Equity and Venture Capital funds may turn out to be very beneficial, not only in financial terms. Capital allows you to increase your income quickly by investing in fixed or current assets, but several other benefits exist. The fund may also provide a company with its network of contacts or knowledge, which might help the firm scale its entrepreneurial activity much faster, which equals more significant capital gains.