The main investment strategies in private equity are venture capital and leveraged buy-outs, but strategies such as growth capital (which could be viewed as late-stage venture capital), distressed investments and mezzanine capital are also included in the definition of private equity.

Private equity funds are organised as investment vehicles with a much longer investment horizon than funds that invest in public companies, usually a 10-year period.

Each fund has a private equity fund manager, and each manager can manage several funds at once. However, only one of the manager’s funds should invest at a time to avoid conflicts of interests.

The governance and incentive structure is defined through a limited partnership agreement between the fund manager (often referred to as the GP or General Partner) and the investors (LPs or Limited Partners). The rationale behind the long life-time of a private equity fund is that the fund manager shall have sufficient time to be able to invest in companies during a defined investment/commitment period; then develop the portfolio companies through exercising value value-adding active ownership and then finally divesting what should be high value companies, when the fund manager deems the timing to be right, towards the end of the fund’s life time.

Venture Capital (also referred to as VC or Venture)

VC is capital being invested into early-stage, high potential companies with the goal of achieving a high return on investment. Venture investments are normally done in high-technology industries (e.g. ICT and biotechnology), and usually with minority stakes, however, VC funds tend to invest together and thereby gaining effective control over the company. Debt is very uncommon in VC (though there are circumstances where venture debt is given), as banks consider the risk to be too high since the companies do not have a positive cash flow yet. A core skill within VC is the ability to identify novel technologies that have the potential to generate high commercial returns at an early stage. The venture capital fund manager is not only providing capital, but also skills to build great companies.

The difference between seed capital and venture capital is that venture capital investments tend to involve significantly larger sums of capital, and there is much greater complexity involved with regards to contracts and corporate structure.

Seed financing is provided to research, assess and develop an initial concept before a business has reached the start-up phase. The start-up phase normally relates to companies in the process of being set-up or companies that have been operational for a short time, but have not sold their product(s) commercially (also referred to as pre-revenue phase).

However, it is important to note that early stage venture includes both the seed and start-up phase of a business, as to avoid confusing the terms. Late stage venture investments include expansion capital, which could also be referred to as growth capital.

Growth capital is a type of investment, most often a minority investment, in relatively mature companies that are looking for capital to expand or restructure their operations, enter new markets or finance a significant acquisition. This is usually done as a partnership between the new owner(s) and the current owner(s), who normally will not sell any their holdings when the growth capital is provided. Growth capital is often viewed as a late-stage venture investment.

Leveraged buy-outs (LBO or just BO)

BO are types of investments where a controlling equity stake is being acquired, and which involves the use of high leverage/debt. The acquisition company’s cash flow will be used for paying interest and installments on the acquisition debt. A relevant acquisition target normally has characteristics such as low current debt, stable cash flows as well as an identified future potential for improvements so that going forward the management can make operational or various other improvements in order to further boost the firm’s cash flows.

The advantages of this kind of transaction are two-fold:

1) The investor only needs to participate with a part of the capital required for the acquisition

2) If the returns of the investment are higher than the cost of debt, then the returns to the financial sponsor will be enhanced. On the other hand; taking on more debt increases the financial risk for the investor, and poor trading performance could result in a situation where the equity stake would lose its value and ultimately a part of the debt could end up having little or no value.

Distressed investments are investments in companies that are in or are close to bankruptcy. This is normally a result of bad operational performance and thus insufficient cash flow means the company is unable to meet its debt obligations. The investors will often strive to influence the way the debt in being reorganised, and make sure that a proper turn-around plan is being implemented in order to get the company back on track again.

Mezzanine capital is subordinated debt or preferred equity which represents a claim on the company’s assets, which ranks to senior to common shares, but normally behind other debt instruments.