Private equity refers to any type of equity capital or investments in assets that are made available to companies or investors that are not listed or quoted on a public exchange. Investments are characteristically drawn from an active, dynamic and value-added management strategy. The funds generated through private equity can actually go to a variety of uses. It can be used to develop new products and technologies, to make acquisitions, to reinforce the balance sheet of the company, or to increase the working capital. Since a private equity is not listed on an exchange, an investor who wishes to sell his stake or securities in private corporations has to find a buyer in the absence of a traditional market place like the stock exchange.

Moreover, transfer of private equity is strictly regulated since several transfer restrictions on private securities are enforced. In general, returns on their investments are obtained in one of three ways:

1. Through an initial public offering (IPO), which is the process where a private company sells its stocks or shares to the public market for the first time. An IPO is usually issued by a smaller and younger company that seeks to grow its capital. However, a large private company that seeks to become openly traded can also do it. In order for the sale to be made possible, the company must first need to retain the services of an investment banker to underwrite the issue. The underwriter helps the company determine what type of security should be issued, the best offering price, and the proper time to sell it to the public market.

2. Through a sale or merger of the company they control. The merger is a combination of two or more companies wherein the decision is usually mutual for both firms. It generally occurs by offering the stakeholders of one company with securities in the acquiring corporation in exchange for the surrender of their stock.

3. Through recapitalization, the process of restructuring a company’s debt and equity mixture, generally with an objective to further improve and stabilize the working capital structure of the company. Businesses often want to expand their debt-to-equity ratio to enhance their liquidity. Moreover, recapitalization may involve the exchange of one form of financing for another or exchanging the current debt for a new debt that offers a lower interest rate or a much longer maturity. It may also involve eliminating the chosen shares from the company’s capital structure and replacing them with reorganization bonds or common stock. Recapitalization can also be done for other reasons including defending against takeovers, lessening taxes, or as an alternative exit strategy for venture capitalists and leveraged buy-out sponsors.

Additionally, the company may sell unlisted securities straight to investors (described as a private offering) or to a private equity fund, by which contributions from smaller investors are collected to produce a capital pool.

HISTORY

The origin of private equity can be traced back to 1901 when J.P. Morgan acquired Carnegie Steel Company from Andrew Carnegie and Henry Phipps for $480 million dollars. This was the first trade on what is now called private market. In 1907, Phipps established the Bessemer Trust, devoting his $50 million in proceeds to private companies and other exclusive holdings.

In 1946, two of the earliest venture capitals were created, the American Research and Development Corp. (ARD) and the J.H. Whitney & Company. ARD was established by Georges Doriot, the “father of venture capitalism.” The company believed that by endowing management with skills and funding, they could persuade other companies to do well and eventually generate revenue themselves. ARD’s greatest accomplishment was its acquisition of Digital Equipment Corp. for $70,000 and then selling it for $37 million, which was an increase of 52,257%. On the other hand, J.H. Whitney’s renowned investment was a groundbreaking method for delivering nutrition to U.S. troops, soon known as Minute Maid Orange Juice.

In 1958, President Eisenhower enacted the Small Business Act, which permitted licensed venture capital companies known as Small Business Investment Companies or SBICs to borrow money from the government at low interest rates, provided that they invest in entrepreneurial ventures. In the 1960s, the rise of IPOs became popular and in 1964, the first leveraged buyout was made by the Kohlberg Kravis Roberts & Co. After the stoppage of investments during the 1970s due to a failing market, fund raising increased from $39 million in 1977 to $570 million in 1978, as reported by Time magazine. In the 1980s, FedEx, Intel, Genentech, Apple, and several more companies grew because of private equity or venture funding.

TYPES

Private equity investments are categorized into four types, namely:

1) Venture Capital - an investment to establish a new company, or expand a smaller company that has undersized or budding revenues or a company with limited operating history and cannot raise funds through debt issues. Previously termed as a risk capital, venture capital is funding a company that presents the opportunity of profit along with the possibility of loss.

2) Buy-out - an investment transaction wherein a whole company or a controlling part of the stock of a company is sold. Thus, buying out a company allows the acquiring company to take over assets and/or operations. The acquisition generally involves a change of ownership and it can be in the form of leveraged buyout, a management buyout, or a venture capital.

3) Merchant Banking - an activity that includes corporate finance undertakings such as a negotiated private equity investment by the financial institutions in the unregistered securities of private or public companies.

4) Special Situation – includes investments in a troubled company or a company where profit could be obtained in effect of a one-time chance such as when industry trends or government regulations are changed.

Companies involved in private equity include the Blackstone Group L.P. and the Carlyle Group. Blackstone Group is based in New York and is the world leader in private equity investing, being able to manage five general private equity funds and a specialized fund with investments in media and communications. The Carlyle Group is based in Washington, D.C., and focuses on venture and growth capital, real estate, leveraged buyouts and leveraged finance investments.

Resources

1. Press releases for some of the largest private equity businesses in the U.S, such as the Blackstone Group, Brentwood Associates, the Carlyle Group, General Atlantic, KKR, and TH. Lee Partners.

2. View information about the World of Real Estate

3. View resources for private equity success stories like Stephen Schwarzman, Ted Waitt, etc.