private equity strategies

Leveraged buyouts (LBOs) ⇒ are the most common type of private equity fund investment. “Leveraged” refers to the fact that the fund’s purchase of the portfolio company is funded primarily by debt. When a private equity fund acquires a publicly traded company in an LBO, the company is said to be “going private.”

Two types of LBOs are management buyouts (MBOs), in which the existing management team is involved in the purchase, and management buy-ins (MBIs), in which an external management team will replace the existing management team.

In an LBO, the private equity firm seeks to increase the value of the firm through some combination of new management, management incentives, restructuring, cost reduction, or revenue enhancement. Firms with high cash flow are attractive LBO candidates because their cash flow can be used to service and eventually pay down the debt taken on for acquisition.

Developmental capital or minority equity investing refers to the provision of capital for business growth or restructuring. The firms financed may be public or private. In the case of public companies, such financing is called private investment in public equities (PIPEs).

Venture capital funds invest in companies in the early stages of their development. The investment often is in the form of equity but can be in convertible preferred shares or convertible debt. While the risk of start-up companies is often great, returns on successful companies can be very high. This is often the case when a company has grown to the point where it is sold (at least in part) to the public via an IPO.

Venture capital fund managers are actively involved in the development of their portfolio companies, often sitting on their boards or filling key management roles.

Categorization of venture capital investments is based on the company’s stage of development. Terminology used to identify venture firm investment at different stages of the company’s life includes the following:

1. The formative stage refers to investments made during a firm’s earliest period and comprises three distinct phases.

•  Angel investing or pre-seed capital refers to investments made very early in a firm’s life, often the idea stage, and the investment funds are used for business plans and assessing market potential. The funding source is usually individuals (“angels”) rather than venture capital funds.
• The seed stage or seed capital refers to investments made for product development, marketing, and market research. This is typically the stage during which venture capital funds make initial investments, through ordinary or convertible preferred shares.
• The early stage or start-up stage refers to investments made to fund initial commercial production and sales.

2. Later-stage investment or expansion venture capital refers to the stage of development where a company already has production and sales and is operating as a commercial entity. Investment funds provided at this stage are typically used for expansion of production and/or increasing sales through an expanded marketing campaign.

3. Mezzanine-stage financing refers to capital provided to prepare the firm for an IPO. The term refers to the timing of the financing (between private company and public company) rather than the type of financing