Private Equity Investment Types

The Private Equity sector is broadly defined as investing in a company through a negotiated process. Investments typically involve a transformational, value-added, active management strategy.
Private Equity investments can be divided into the following categories:

• Venture capital: an investment to create a new company, or expand a smaller company that has undeveloped or developing revenues
• Buy-out: acquisition of a significant portion or a majority control in a more mature company. The acquisition normally entails a change of ownership
• Special situation: investments in a distressed company, or a company where value can be unlocked as a result of a one-time opportunity

Private equity firms generally receive a return on their investments through one of three ways: an IPO, a sale or merger of the company they control, or a recapitalization. Unlisted securities may be sold directly to investors by the company (called a private offering) or to a private equity fund, which pools contributions from smaller investors to create a capital pool.
Considerations for investing in private equity funds relative to other forms of investment include:

• Substantial entry costs, with most private equity funds requiring significant initial investment plus further investment for the first few years of the fund.
• Investments in limited partnership interests are referred to as "illiquid" investments which should earn a premium over traditional securities, such as stocks and bonds. Once invested, it is very difficult to gain access to your money as it is locked-up in long-term investments which can last for as long as twelve years. Distributions are made only as investments are converted to cash; limited partners typically have no right to demand that sales be made.
• If a private equity firm can't find good investment opportunities, it will not draw on an investor's commitment. Given the risks associated with private equity investments, an investor can lose all of its investment if the fund invests in failing companies. The risk of loss of capital is typically higher in venture capital funds, which invest in companies during the earliest phases of their development, and lower in mezzanine capital funds, which provide interim investments to companies which have already proven their viability but have yet to raise money from public markets.
• Consistent with the risks outlined above, private equity can provide high returns, with the best private equity managers significantly outperforming the public markets.

For the above mentioned reasons, private equity fund investment is for those who can afford to have their capital locked in for long periods of time and who are able to risk losing significant amounts of money. This is balanced by the potential benefits of annual returns which range up to 30% for successful funds.