In finance, the field of alternative investment is rapidly growing. This asset class includes all assets outside traditional investments. The types of traditional investments are stocks, bonds and cash.
Private equity, which is capital investment in private companies, is one type of alternative investment that has gained popularity. Private companies are companies or funds outside those on the public exchange or those that are publicly traded on the stock market. After all debt is cleared, the amount and value of the private company’s stake or share that belongs to the shareholder is the equity.
In any private organization or company an investor wishes to invest in, there are three key types of private equity strategies that can be employed. These strategies work in synergy and each has a place in particular stages in life cycle of the private company.
1. Venture Capital
Often made in an early-stage startup and thus inherently risky, venture capital refers to the amount of seed funding capitalists give in exchange for a share of the company. Often the required share is within 15% – 20% per round of financing. Investors not desiring a controlling share increases the appeal of this strategy to company owners. The high amount of risk is because these startups haven’t yet proven their ability to turn a profit. This makes venture capital investing both a gamble and a strategic art. This strategy has a high level of persistence. Capitalists with a proven track record have a greater-than-average chance of choosing a company with a high success rate.
2. Growth Equity
The second strategy involves investment in a company that is already established and is experiencing growth. These companies have reached a stage where funding is needed to continue growth and increase market share. This is where investors have a role to play. The investors provide this capital in exchange for a typically minority share of the company’s equity.
Growth equity investors have an advantage venture capitalists do not: a history to use in considering what company is best fit to invest their money in, such as the company financial track record and clients. To ensure the product is itself worth backing, investors can try it out for themselves. This advantage, to an extent, reduces the level of risk as the company can show its ability to pull in a return before investment is made. To reasonably estimate investment return over time, the investor can also require a growth strategy from the company. Overall, it’s best to look out for a strong team, careful research and financial analysis.
There’s a third strategy for mature companies. This final private equity strategy occurs when a company is bought by either a private equity firm or its existing management team who then becomes the sole investor holds a controlling share of the company.
This requires a large portion of funds to pull off and involves significant risk. With buyouts, investors have two options:
Management Buyouts: This involves the company’s already existing management team buying the company’s assets and acquiring a major share which is over 50 percent. It works best in situations when the company needs to go private and be restructured internally. Business owners who are close to retirement often use management buyouts as an exit strategy.
Leveraged Buyouts: These are buyouts funded with borrowed money and often work best when companies desire to make major acquisitions without spending too much capital.
Using these strategies requires skill but having the basic knowledge about these strategies improves your ability to build profitable portfolios.
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