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.
FAQs
It's no secret that private equity firms have a bad reputation. They're often seen as ruthless vultures that swoop in to buy up struggling companies, slash costs, and then sell them off for a profit.
What is the dark side of venture capital? ›
Competition for deals: Competition for deals is another common challenge faced by VC firms. With many VC firms vying for the same deals, it can be difficult for a firm to stand out and secure the best investments. Misalignment of interests: Misalignment of interests is a common problem in VC.
Are private equity firms ethical? ›
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. This can include actions such as layoffs, cutting employee benefits, and engaging in environmental practices that harm communities.
Which is better private equity or venture capital? ›
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.”
What is private equity and why is it killing? ›
The basic idea is simple: Private equity firms make their money by buying companies, transforming them and selling them — hopefully for a profit. But what sounds simple often leads to disaster. Companies bought by private equity firms are far more likely to go bankrupt than companies that aren't.
Why are people in private equity so rich? ›
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.
What is the biggest risk in venture capital? ›
The risks of venture capital include agency costs, information asymmetry, and moral hazard. The risks of venture capital include financial, market, strategy, technology, production, human capital, and legal risks.
Are venture capitalists risky? ›
Venture capital is a high-risk, high-reward type of investment, and there is no guarantee of success. While VC firms aim to identify the best opportunities and minimize risk, investing in startups and early-stage companies is inherently risky, and there is always the potential for loss of capital.
Are venture capitalists sharks? ›
The sharks are venture capitalists, meaning they are "self-made" millionaires and billionaires seeking lucrative business investment opportunities. While they are paid cast members of the show, they do rely on their own wealth in order to invest in the entrepreneurs' products and services.
Why is private equity controversial? ›
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.
Compared to consultants, private equity professionals often have more influence and a more direct impact on the companies with which they work. With this power, however, comes greater accountability, as they're more deeply involved as company shareholders.
How long do private equity firms keep companies? ›
The average holding period for portfolio companies in private equity is typically between 3 to 5 years. In the last 10 years, the median holding period has almost doubled, increasing from around 3 years to nearly 6 years.
Is BlackRock a private equity firm? ›
Private equity is a core pillar of BlackRock's alternatives platform. BlackRock's Private Equity teams manage USD$41.9 billion in capital commitments across direct, primary, secondary and co-investments.
Why do investors prefer private equity? ›
Because private equity investments take a long-term approach to capitalising new businesses, developing innovative business models and restructuring distressed businesses, they tend not to have high correlations with public equity funds, making them a desirable diversifier in investment portfolios.
Is venture capital riskier than private equity? ›
VC tends to be the riskier of the two, given the stage of investment; however, either type of investment could go awry in certain scenarios. At the same time, VC investments tend to be smaller than private equity investments, so fewer dollars may be at stake.
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.
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 worse than investment banking? ›
Both investment banking and private equity are demanding careers that require long working hours, although private equity firms tend to have a more relaxed work environment and offer a more flexible schedule.
What is the disadvantage of working in private equity? ›
Drawbacks / Disadvantages:
Still fairly long hours and an intense work environment, and significant travel may be required, especially as you advance. There may not be a clear path to advancement at your firm, depending on the firm's size and policies and your level.
