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Private Equity sector is broadly defined as investing in a company through a negotiated process. Investments typically involve a transformational, value-added, active management strategy. Private Equity investments can be divided into the following categories:
- Venture capital: an investment to create a new company, or expand a smaller company that has undeveloped or developing revenues;
- Buy-out: acquisition of a significant portion or a majority control in a more mature company. The acquisition normally entails a change of ownership;
- Special situation: investments in a distressed company, or a company where value can be unlocked as a result of a one-time opportunity (Changing industry trends, government regulations etc.);
- Merchant banking: negotiated private equity investment by financial institutions in the unregistered securities of either privately or publicly held companies.
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Private equity firms generally receive a return on their investments through one of three ways: an IPO, a sale or merger of the company they control, or a recapitalization. Unlisted securities may be sold directly to investors by the company (called a private offering) or to a private equity fund, which pools contributions from smaller investors to create a capital pool.
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The seeds of the private equity industry were planted in 1946 when the American Research and Development Corporation (ARD) decided to form to encourage private sector institutions to help provide funding for soldiers that were returning from World War II. While the ARD had difficulty stimulating any private interest in the enterprise and ended up disbanding, they are significant because this marked the first recognized time in financial history that an enterprise of this type had been formed. In addition, they had an operating philosophy that was to become significant in the development of both private equity and venture capital: they believed that by providing management with skills and funding, they could encourage companies to succeed and in doing so, make a profit themselves. During the course of their unsuccessful journey, ARD did succeed in raising approximately $7.4 million, and they did have one rousing success; they funded Digital Equipment Corporation (DEC). By the 1970s such private participation had permeated into the private enterprise formation, but till in the late 1970s, the task was being largely carried out by investment arms of a few wealthy families, such as the Rockefellers and Whitneys.. In the 1980`s, FedEx and Apple were able to grow because of private equity or venture funding, as were Cisco, Genentech, Microsoft, Avis, Beatrice Foods, Dr. Pepper, Gibson Greetings, and McCall Patterns. Despite these successes, through a series of `debt-financed leveraged buy-outs(LBOs)` of established firms, the PE firms were being seen with acrimony and being casted as irresponsible corporate raiders- as a threat to the free capitalist structure. The extreme example of this phenomenon is described in the bestselling book, where the two PE firms Forstmann Little and Kohlberg Kravis Roberts, were described as `Barbarians at the Gate` for their aggressive $25 billion pursuit for RJR Nabisco.
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Most private equity funds are offered only to institutional investors and individuals of substantial net worth. This is often required by the law as well, since private equity funds are generally less regulated than ordinary mutual funds. For example in the US, most funds require potential investors to qualify as accredited investors, which requires $1 million of net worth, $200,000 of individual income, or $300,000 of joint income (with spouse) for two documented years and an expectation that such income level will continue.
Some examples of organizations owned by private equity firms are The Automobile Association, Jimmy Choo Ltd and Boots the Chemist.
