Using the words Venture Capital and Private Equity are usually used together, however there is only one category of private equity, and that is venture capital. Private Equity has different risks. For example, some companies will go through growth changes overtime and this usually requires capital in various different amounts. This capital is also coming from multiple sources. Each stage during a company’s growth is looked at as a “risk continuum”. If your company is young and is barely generating a cash flow, then it become a high risk to fund. Typically a company in this situation would be required to obtain capital from family or friends or angel investors. Once the company starts generating revenue, then the risk becomes much less.
Venture Capital is usually for established products or services that are looking to get out into the market. Various investors are always seeking for the newest and greatest product that consumers will absolutely love. Some of the major computer companies have used venture capital to fund their operation. This type of funding is looked at as a private partnership. Venture Capitalists will provide the equity financing that is needed in exchange for a stake. They usually will play a day to day role for guidance in order for the investment to take off within a few years. Most of venture investments do not make it far but for the ones that do, they can bring a huge return making their overall investment back and then some.
There are other private equity options such as LBOs and Mezzanines. These are often used once the company has grown some and is a little more secured. They may require some debt and equity however the overall risk is much lower with a low fail rate.
LBO stands for Leveraged Bayouts. They are one of the most common loans that are used for private equity. A company obtains a loan from a private equity firm which is then secured by cash or company assets. Sometimes the LBO is sold in several pieces and any cash that is generated would be used as a down payment for high leverages. This type of process was very big a couple decades ago however now LBO deals are more focused on purchasing businesses with the intent to add value to the companies assets rather than having the company sell pieces of their structure.
Mezzanines Financing is just a private loan. This type of loan either comes from a commercial bank or a venture capital firm that specializes in Mezzanines. They usually include subordinanted loans or common stocks. When you don’t take on a full equity position, then a firm that specializes in mezzanine debt can decrease its risk. This is based on capital preservation.
In order to engage in a private equity or venture capital partnership, the investor should be accredited. Sometimes even the net worth must exceed a million dollars. For investors who’s net worth is a little lower, then they have the option for exchange trade funds. Exchange Traded Funds are a Private Equity Index. There is a list of numerous publicly traded companies that will invest into private equity.
Overall private equity has several forms and venture capital is just one of those that can assist a company during different growth stages. It’s all based on how the market is turning and the existing cycles.