What are the Different Types of Private Equity Financing?

John Lister
John Lister
Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

Private equity financing refers to all forms of equity other than issuing stock in a company for public trading. Equity financing means that the people giving money to the company take some form of ownership stake, rather than creating a debt that the company must repay later, as happens with bonds and loans. The main differences between various forms of private equity financing relate to what the investors hope to gain from the investment.

The simplest form of private equity financing is growth capital. Investors simply pay money to buy a proportion of the company, hoping to get a return from their share of future profits. Normally, such investments are designed to fund specific capital asset spending, such as building a new factory, that should in the long term increase the company's profits.

Relatively new companies will often prefer venture capital. While there isn't a single defined border between this and growth capital, the general difference is that venture capital is for small companies that have the potential to grow quickly with adequate financing. Because of this, there is more of a risk of the company failing and the investors losing money. In many cases, a venture capital investor won't be expecting to make much money from his share of profits and will instead be hoping to make a large windfall if and when the firm becomes a publicly traded company.

Mezzanine capital involves the investor taking on a form of low-priority ownership in the company. This means that if the company fails, the investor will be among the last people to have a claim on any remaining money, and thus has a comparatively high risk of losing out. As a result, mezzanine capital investors will usually be offered not just the ownership, but a guaranteed cash return as well. This means mezzanine capital is strictly a hybrid of equity and debt financing.

A leveraged buyout is a form of private equity financing that involves the entire business being sold in a way that pays off existing shareholders, while leaving money left over to improve the company's financial position. The leverage refers to the fact that the organization taking over the company does not finance the takeover entirely with its own money. Instead, it borrows money from third-party investors, using ownership stakes in the company being taken over as collateral. For example, company A may take over company B in a leveraged buyout, using money borrowed from investors C & D, as well as its own funds. If company A cannot repay the loan, C & D will automatically take an ownership stake in company B.

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