business
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If you read the media, you may have a poor opinion of both Private Equity and Venture Capital, but it can be claimed that both these investors/business funders have a valuable contribution for the growth of businesses and the economy in general.
There are many articles in the press and online that give an extremely negative view of PE and VC, even giving pejorative nicknames like “vulture capital.” Critics claim private equity firms are bloodsuckers that pile healthy companies with debt then strip out their asset, leaving a lifeless shell.
Needless to say, some PE and VC deserve this bad reputation, but they are mostly the exception, and many Private Equity and Venture Capital funds provide a valuable service.
Wikipedia describes these investment funds as:
'Private-equity capital is invested into a target company either by an investment management company (private equity firm), or by a venture capital fund, or by an angel investor; each category of investor has specific financial goals, management preferences, and investment strategies for profiting from their investments. Each category of investor provides working capital to the target company to finance the expansion of the company with the development of new products and services, the restructuring of operations, management, and formal control and ownership of the company.
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In addition to investments by high-net-worth individuals, these investment funds raise their capital from public and private pension funds, insurance companies, sovereign wealth funds (state-owned investment funds making a country’s assets work for their citizens) and even charities and charitable foundations. The chances are you are benefiting from PE/VC via you pension funds or insurance companies who invest their income to cover claims costs and to keep your premiums lower.
T
he British Venture Capital Association (BVCA), describe these funders as follows:
'Venture capital is focused on early-stage companies with high growth potential, private equity firms invest in a much wider range of companies. Often, they’re mature firms that have been trading for a long time but need access to funds either to fuel growth or to recover from financial difficulties. Private equity and venture capital delivers for both institutional investors, including UK pensioners, and for the wider economy by driving innovation, building British business, and supporting communities and individuals to succeed.
The common criticism of private equity is that it's parasitic and destroys jobs. But PE firms are incentivised to make companies more efficient, if a PE firm saddles a portfolio company with such a heavy debt burden that the company is unable to return a profit, the PE firm ultimately suffers.
Image by Tumisu from Pixabay
A private equity firm will hold a majority ownership stake in a company, with the management team also owning a significant share of the equity. The management team continue to run the business on a day-to-day basis with strategic guidance and support from the private equity firm. After a period of between three to seven years the company would seek an exit, either in the form of a sale to another buyer or a public listing. This can allow the founder to turn his or her investment into money, or an opportunity for a management buyout.
Private equity allows firms, including SME and mid-size businesses an alternative way to raise capital without going through the bank loan process or needing to place their companies up for public offer on the stock market. These structures allow businesses to focus less on quarterly performance and more on the overall growth and big picture.
Love them or hate them, they have a place in business that cannot be denied.
Ian Garner
Ian Garner is a retired Fellow of the Chartered Management Institute (FCMI) and a Fellow of the Institute of Directors (FIoD).
Ian is a Board Member of Maggie’s Yorkshire. Maggie’s provides emotional and practical cancer support and information in centres across the UK and online, with their centre in Leeds based at St James’s Hospital.
He is founder and director at Practical Solutions Management, a strategic consultancy practice and skilled in developing strategy and providing strategic direction, specialising in business growth and leadership.
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They are often seen as ruthless cost-cutters who gut companies and lay off workers in order to make a quick profit. And while it is true that some private equity firms do engage in these practices, it is important to remember that not all private equity firms are evil.
Why do people not like private equity? ›
Private equity funds are illiquid and are risky because of their high use of debt; furthermore, once investors have turned their money over to the fund, they have no say in how it's managed. In compensation for these terms, investors should expect a high rate of return.
What is venture capital and how does it differ from private equity? ›
Private equity funds refer to investments made by investors for investment purposes. Whereas, venture capital refers to funding to those ventures that are backed by new entrepreneurs, have high risks, and who require money to shape their ideas.
What is the downside of private equity investment? ›
Higher risk: Private equity investments often involve significant risks, including the potential loss of your entire investment, which must be part of the individual investors' consideration process.
What is private equity and why is it bad? ›
Private equity investing is done in private companies, which are not listed on public exchanges like the companies you can invest in via the stock market. While it has the potential for high returns, it also comes with risk.
Why is private equity bad for business? ›
Across the economy, private-equity firms are known for laying off workers, evading regulations, reducing the quality of services, and bankrupting companies while ensuring that their own partners are paid handsomely.
What is the curse of private equity? ›
It's known as the “winner's curse.” In private equity investing, it's when a winning bid to acquire a company exceeds its intrinsic value or worth.
Are private equity firms bad for the economy? ›
These firms typically generate high returns and contribute to economic growth, but tax benefits can lead to reduced public revenue, widening income inequality, and short-term investment strategies.
What is the biggest challenge in private equity? ›
9 Key challenges private equity firms face in 2024
- 05 Growing cybersecurity & data privacy risks.
- 06 Growing focus on retail investors.
- 07 The struggle to hire the industry's best talent.
- 08 Rising operational costs.
- 09 Demand for ESG & sustainable practices.
- 10 The legal operating system for private equity.
Another key difference between the two is venture capital “typically involves higher risk but offers the potential for substantial returns,” says Zhao. In comparison, private equity “usually involves lower risk compared to VC investments but may offer more modest returns.”
When transitioning from venture capital to private equity, it's important to negotiate your compensation package carefully. Private equity firms often offer different compensation structures than VC firms, so it's important to be aware of what you're getting into.
How do private equity firms make money? ›
Private equity owners make money by buying companies they think have value and can be improved. They improve the company or break it up and sell its parts, which can generate even more profits.
How do you protect downsides in private equity? ›
Downside Protection — The Bottom Line
As we've discussed previously, investors can potentially reduce exposure to risk at the portfolio level through intelligent asset allocation, diversification, allocating to private-markets assets, and limiting the degree of correlation between assets.
Why do investors prefer private equity? ›
Since private equity funds have far more control in the companies that they invest in, they can make more active decisions to react to market cycles, whether approaching a boom period or a recession. The result is that private equity funds are more likely to weather downturns.
Is private equity ruthless? ›
In the relentless pursuit of maintaining profit margins and delivering on their promises of outsized returns, many private equity firms have embraced a ruthless approach to cost-cutting that has drawn widespread condemnation.
Is private equity parasitic? ›
Private equity has succeeded in depicting itself as part of the productive economy of health care services. even as it is increasingly being recognized as being parasitic.
Is private equity ethical? ›
Private equity firms may face pressure from investors to maximize returns, which may conflict with the desire to invest in socially responsible companies. There is also a risk that private equity firms may be tempted to engage in actions that are unethical or socially irresponsible in order to boost short term returns.
