How To Start A Business With Private Equity
By Viktoriia Dorofeieva
Private equity is a type of capital investment constituting an external source of financing for companies. An investor that regularly manages the assets of third parties. He usually has an interest in a long-term increase in the value of the company. It’s for realizing a profit at the moment of future sales of shares.
Additionally, the funds transferred to the companies may take the character of both own and hybrid financing. For example, a combination of own and debt financing. Apart from the financial contribution, the company may receive from investor management support of various nature. For instance, legality, tax, and organizational consulting.
An average private equity investment takes about 5-7 years. In the case of private equity, the investor bears an increased risk in return for a relatively higher, possible return on invested capital.
Private equity is particularly popular in the case of financing undertakings with increased risk. For example, financing the activities of newly established companies developing an innovative product or technology. In addition, a major benefit of using private equity for an inexperienced organization is the advice received from the investor.
Categories of private investments
If the company changes its shareholder structure with increasing financial leverage, which allows it to capitalize savings on sources of funds, replacing more expensive equity with borrowed funds. It’s called a leveraged buyout.
With this, the target company changes the structure of its sources of funds, replacing relatively expensive equity with borrowed funds. Within a few years, the borrowed funds are repaid and equity capital is increased. After 4-6 years the company is sold to a new owner. At the same time, the cost of capital savings remains with the company that conducted the LBO.
The most likely LBO targets are companies whose credit risk is currently low. Undervaluation is a criterion that increases attractiveness. Positive factors in deciding on a financed buyout are:
- Stable cash flow (or earnings before interest, taxes, and depreciation)
- Low financial leverage at the moment
- Predictable level of capital expenditures
Venture Capital is an investment in start-up companies with high potential returns and a high level of risk.
You can read more about it here.
It’s an investment in relatively mature companies to bring them to new markets, expand their operations, or make significant acquisitions without passing control of the business.
An example of such a strategy is the American investment company Providence Equity Partners LLC. It invests privately in media, communications, education, and information technology. The firm specializes in transactions such as funded buyouts and capital growth and has invested in more than 140 companies around the world since its inception in 1989.
It is a relatively large loan, usually unsecured or with a deeply subordinated collateral structure. For example, a collateral right to the property of the third stage, but without recourse against the borrower.
Under the standard offer, the loan is accompanied by a tear-off certificate. Such a coupon is giving the right to acquire a certain number of shares or bonds at a specified price within a certain period. A similar mechanism that allows the lender to participate in the future success of the project. Mezzanine loans can be used to finance a new company or to acquire a controlling interest through borrowed funds.
Scaleups are companies that focus on:
- increasing access to markets
- revenue growth
- product value-added or employee numbers
- implement win-win strategies as they interact with market leaders and breakthrough companies.
In another approach, scaleups are companies that occupy a certain niche and show significant market growth.
Once the company has solved the initial tasks of market research, development, and has overcome the “growth abyss”. It turns from a startup into a scaleup. To evaluate the results of a startup, in this case, we should consider the level of income, number of active users, number of active clients, or effective coverage relative to the number of funds raised.
The difference between a startup and a scaleup is that –
the main task of the startup is to find and verify a scalable business model.
While a scaleup should focus on expanding its business within the existing business model, with strict control of operating costs.
The key steps for a company in its transition from a startup to a scaleup are:
- correctly define a product
- select a specific market segment
- define the best market strategy
Several major international players have emerged in the ecosystem around scaleup: