Being an aspiring commercial lawyer often means being confronted by complex, often abstract, concepts leading to an often impenetrable wall of jargon for students and trainees. Next up in our Legal Lingo series, which we've introduced to help break down this jargon, is an explanation of the different types of private equity investments.
The purpose of Private Equity (PE) is to acquire equity ownership stakes in companies, enhance those company’s value through strategic management and operational improvements, and ultimately achieve profitable exits.
The process varies based on the company’s growth stage, which can be broadly categorised into three phases: Venture Capital, Growth Capital, and Buyout Capital.
Venture Capital
Early-stage venture capital (VC) is a form of financing that targets startups and small businesses that are believed to have significant long-term growth potential. These enterprises typically lack the extensive operating history and collateral required to obtain traditional bank loans. As a result, venture capitalists step in to provide the essential funding needed to propel these companies forward.
In addition to financial support, VC firms often offer strategic guidance, leveraging their industry expertise and networks to help startups refine their products, scale their operations, and achieve sustainable growth. This comprehensive support is crucial for young companies as they navigate the challenges of early development and strive to establish a foothold in their respective markets.
There are two main phases of VC investment depending on the company’s maturity:
- Pre-Seed – these investments fund very early-stage businesses, usually sourced from founders, family, friends, and angel investors, covering initial costs and transforming ideas into viable business concepts.
- Seed and “Series” Rounds – these are crucial investment stages post-pre-seed, focusing on product development, market research, and scaling, heavily supported by venture capital firms.
VC investing is seen as high-risk largely due to the infancy of these businesses, meaning there is generally a lack of historical information (financial and commercial) for investors to diligence and forecast against. However, as these investments are so early in the business’ life, they have the potential to offer huge rewards. Investment firms which specialise in VC will mitigate the high risk nature by typically spreading their investments across multiple startups to diversify their venture portfolios as they are aware the success rate for startups is extremely low.
Growth Capital
Growth capital investing, also known as growth equity or expansion capital, involves providing funding to established companies that are looking to expand their operations, enter new markets, or accelerate their growth. These companies typically have a proven business model, steady revenue streams, and are seeking additional capital to scale their operations without taking on excessive debt.
Growth funds are used for various growth initiatives such as expanding production capacity, entering new geographic markets, developing new products, rebranding, or making strategic acquisitions.
Growth capital investments will typically take minority stakes with little intervention in management affairs. The investment horizon is usually 3-7 years, with potential for strong returns by expediting growth.
Buyout Capital
Buyout capital, also known as leveraged buyout (LBO) investing, involves acquiring a controlling (or entire) equity interest in an established company, often using a combination of equity and significant amounts of debt (leverage). LBO’s target companies with stable cashflows and profitability that are still perceived to be undervalued.
The focus is on improving the company’s performance through cost reductions, revenue growth, operational efficiencies, and strategic repositioning. Investors may also pursue bolt-on acquisitions to expand the company’s market position.
LBO’s are the lowest risk among the three stages of investment due to the stability of the target companies. The typical exit timescale is 5-7 years, with the common exit strategies involving a sale to another company, a secondary buyout, or an initial public offering (IPO).
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