Private EquityHedge Funds
Private equity markets fund companies in of need financial backing while privately owned. Instead of entering the public financial exchanges, these firms choose private equity funding. They may not be ready for public trading, or simply do not wish for the reduction in control which occurs after an initial public offering. Private Equity Hedge funds deliver cash acquired from investors to firms seeking funding. Delivery occurs via loans or direct purchases of a firm’s equity. In both cases, the firm receives capital and the hedge fund plans to receive its money back, either by repayment of the loan or capital gains after the sale of equity.
Private equity can be divided into many categories based on the stage of business funding. Stages of funding include Seed Round, Mid Stage, Late Stage, Mezzanine, and Private Funding. An initial public offering will transition the company from private to public. Publicly traded companies still occasionally acquire funding through the private equity markets instead of public avenues.
Private Equity: Venture Capitalism
Seed, middle, and late stage funding are all subsets of venture capitalism. Venture capitalists helps startups and younger firms grow by providing loans and purchasing equity, depending on confidence in financial performance. Loans are typically offered in lower levels of confidence while share investments are offered at higher levels of confidence, but these rules are not absolute. Firms use these to accelerate marketing, hiring, and business operations. Venture capitalists invest in many firms acknowledging most will fail. The venture capital firm receives its investment back when firms repay loans, are sold for acquisition, or reach an initial public offering allowing exchange based trading.
Seed stage funding occurs when private equity or venture capital firms give money to those who essentially only have an idea, prototype, or very limited production line. The inventor uses this money to create or expand working prototypes and fund the company’s initial stages. Venture capitalists reject most ideas for seed firms. A common urban myth is funds reject 90% of received offers while funding 9% that fail and 1% that actually succeed. Seed funding has extremely high risk, but if they are successful they provide the most financial profit.
Private Equity: Late or Mezzanine Funding
Later stages of funding attempt to avoid firms which haven’t cleared young company’s common obstacles. Funds in mid or late stage funding have cleared the basic set of issues, and have some room for substantial profit remaining. If they grow a little further, they will reach mezzanine financing. This is the final stage before the firm should be ready to reward venture capitalists for their investments, either with repayment of a loan or an exit plan for their capital. This exit plan can be acquisition or public offering. Mezzanine financing will help the firm breach the last set of issues which separate them from being a viable public firm. This is the least risky stage to invest in a firm aiming for acquisition or an IPO while under private control.
Private Equity: Funding Permanently Privates
As previously said, firms which are not interested in acquisitions or initial public offerings also seek public funding. These firms may be family held companies or simply disinterested in exchange or public trading regulations. These firms will use the private equity loan or investment to further their business aims long term. The risk level changes with the firm requesting funding. They may be solid or shaky, depending on their business model and financial status. The return must be higher than market alternatives with similar or less risk, or a private equity firm has no reason to invest the money the firm needs.
Benefit: Low Chance to Overlap
A major benefit for private equity hedge funds is a low possibility for overlapping investments. Since these funds do not often invest in publicly traded companies, they are highly unlikely to hold the same assets as other investment holdings. Overlaps with other holdings increases correlations between differing sectors of your investment portfolio. This is great if they’re all encountering positive returns, but disastrous when losses are suffered. Reducing correlations in your portfolio reduces risk, and diversifies potential sources of return.
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