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What are Private Equity’s Four Main Branches?

by Nathan Zachary
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Private equity is a general term that identifies different types of investing methods. Broadly, it refers to investing money into a company that is not publicly traded. Investors aim to invest in a promising brand or startup with the potential to earn better returns. That could include growth equity, special debt, venture capital, leveraged buyout, real estate, and other special situational funds. Funds might specialize in a particular industry or focus on specific geographies and need expert private equity solutions to achieve the best returns.

Let’s dig deeper into the four main branches of private equity funds.

  1. Venture Capital

A venture capital firm is a private equity company that invests in early-stage companies and startups with high growth potential. Venture capitalists earn money for their investments but take only a minority stake in a portfolio company. Consequently, the company’s original management team retains control and operations. 

Venture capital is a somewhat risky option for investors because the portfolio companies are often young with no proven track record. However, taking a risk might yield huge rewards if the company achieves high success.

  1. Buyouts

Private equity (PE) firms might structure their private equity solutions as buyouts, in which they buy an established company and take it private. When that happens, the portfolio company’s existing investors encash their shares, and the buying company becomes the sole investor with controlling shares. Buyouts can be of two types:

  • Management Buyouts: In this buyout type, the company’s management purchases the company’s assets and raises funds through a PE firm. In that scenario, the PE firm takes the company’s minority share in exchange for its investment. All the past investors receive cash for their shares, and the management takes full control. 
  • Leveraged Buyouts: In this buyout type, a private equity fund finances a company using a hefty debt amount, usually 80-90%. It allows the firm to buy a company larger than it could have purchased with fund capital. The buyer often takes a majority stake even after putting its fund towards buying a small part of the company. That gives them control over the company’s strategy and management.
  1. Growth Equity

Private equity firms sometimes select mature companies for investments that are already growing. By investing their capital into a company’s acquisition or expansion, they aim to profit from its growth. However, since it buys only a minority share in the company, it has minimal risk involved. 

Investors often choose companies with no or very low debt, as a result of which they typically receive the desired shares from their investment. Although the investment firm has no say in the company’s management or operations, it typically demands private equity solutions and a growth strategy from the company to estimate its return on investment.‍

  1. Special Situation Investments

In a special situation investment, a private equity firm invests due to a special situation instead of the fundamentals. The case often depends on events, like a world event affecting the company’s foreign business, a rumor spreading about a company deteriorating its reputation, or the government changing regulations that affect the company’s operations. Such events are often positive ones that boost the stock price for the short term. An increase in companies defaulting during the Covid-19 pandemic created ample opportunities for investors looking for special situations.

PE firms specializing in these special situation investments use several techniques to profit from a recovering company. These often include the following: 

Turnaround or Distressed Financing: The PE investment firm takes controlling interests in a distressed company and sells its assets to earn profit. Conversely, it might invest in the firm to turn the business around and bring it to success.‍

Mezzanine Financing: Mezzanine financing often applies to a company looking for a combination of equity and secured debt rather than an option among them.

Private equity funds and companies enter into PE deals for various reasons. That is why different branches have unique structures based on the company’s life cycle, investment goals, and financial situation. Private equity solutions provide immediate funding that a company might not get elsewhere. However, the bottom line is that a PE firm aims to invest in a company for a short period, exit it, and distribute the profits to the investors.

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