Private equity is a system of investment that buys a part, or complete control of a company, with the aim of making a high return on investment on the long run. A group of investors raise fund to buy a portion of, or a company, and enrich themselves with the profit made. The word “private” means that, the investment is private. But, it does not mean that private equity buys only private investment. It buys both public and private investments.
Apart from the benefit of putting money into the purse of investors, private equity renders financial buyout to liquidating businesses. For instance, if A & C limited is liquidating, and there is no equity to offer a buyout premium, The value of the troubled A & C company depreciates maximally. But if there is a private equity deal, the share owners of A & C will have a financial alternative to bankruptcy.
Another benefit of private equity comes when a part of a company’s control is purchased. Many companies who sell parts of their investment don’t do so because they are liquidating. They sell because they need fund to invest in some other thing. It could be to develop a segment of the company’s main business objective.
If the money would not come in short while, and the objective couldn’t wait for a “long time” the private equity would give the company, the needed fund. Then the acquired company would designate the agreed portions of the company’s control for private equity.
Source of fund
Fund has been the bane of private equity, especially in developing countries. The main source of fund has been investment banks, and commercial banks. However, investors in this sector may seek other ways to raise fund, but that depends much on the evaluation of return on investment. The willingness of lenders to partner with private equity is always influenced by the number of existing assets, former, or current investment status.
Just as in many businesses, the risks in Private equity is open, and yet could be contained. The process of acquisition is always open. And that means; every equity manager is invited to appraise, and therefore make a buyout. The tendency of overbidding the value of assets just to beat competition is always there. And that affects long run profit evaluation, leaving the firm on a very loose end.
The negative impression it creates hunts the future sales/buyout of firms. Target buyouts now have exorbitant price tags, leaving private equities to make or mar it.
Debt as bonds: the system of using debt to finance acquisitions is a common method in private equity investment, even though it’s risky. It makes the company vulnerable to loss, if the Purchased company’s return on asset (ROA) is lower than the cost of acquisition.