The term private equity is used to distinguish an investment in a privately held company from an investment in publicly traded stock. Private equity investment refers to several types and strategies of investing in private companies or taking public companies private. An entire industry has been built around private equity investment, which has come to be highly profitable, and yet is still able to avoid the level of public scrutiny that attends other types of deals which involve publicly traded securities.
One of the larger and more common forms of private equity investment is what is known as a leveraged buyout. In this type of transaction, a private equity firm takes on debt in order to raise the funds needed to buy out a public company, or in other words to purchase a majority of its stock, which it then takes off the market. This effectively turns a public company into a private one. The debt that was incurred is then repaid with interest from the efficiently managed earnings of the now-private company. Other times, several private equity firms will pool resources together to be able to finance the deal, rather than one firm taking on all of the debt.
Most other private equity deals do not involve taking over a controlling share of the stock of the target company. Venture capital, for instance, is a form of private equity investment in which an investor will put money up to pay for the start-up of a company that requires large amounts of capital to get going. New technology and biotechnology firms often fall into this category. Such investment in the early stages of a new company is often costly for the beneficiary, and is used when it is not possible to find a cheaper form of financing, such as debt.
Even if a company is not necessarily new, it may still need an infusion of capital to make sweeping changes in the company, or in order to finance an acquisition. Private equity investment that takes place in these situations is known as growth capital. Growth capital can come from any of a variety of sources, including private equity firms. It is best suited to a company that has shown a history of profitability, but does not have the working capital to grow or change in the way its leaders want it to.
Much of what goes on in the world of private equity is just that – private. Because government regulations and securities laws often do not apply, the daily workings of private equity firms are kept hidden from the public. This is done quite intentionally. Significant investment advantages are available in private equity that public companies cannot enjoy, including very large profit margins and little accountability regarding business practices.