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Commercial Question

Going Private

updated on 26 April 2005


What is private equity?


In all walks of life, cash is king. At its simplest, private equity provides another opportunity for a company to raise cash.

Businesses tend to fall in and out of favour with public and professional investors alike, which can mean that a new share issue does not produce the desired financial results. Smaller companies may find it particularly hard to find investment capital. Obtaining an initial listing on the public markets can be expensive because of the onerous listing requirements and the continuing obligations placed on a listed company. Additionally, they may be perceived as a risky investment.

Loans and other products like bonds and debentures may not always be attractive to a company. Too much debt on a company's balance sheet will be unpopular with shareholders and bank managers alike, and the regular repayments may lead to liquidity problems.

Private equity provides a different option. In essence, it is a private subscription for new shares by a corporate investor that takes place outside the public markets, hence the term 'private equity'. There are a range of investors operating in this field, ranging from private equity houses that tend to invest in high-profile and large-scale acquisitions of mature companies, to the venture capitalists whose interests lie more with riskier investments, such as start-up companies and technology projects. In particular, private equity is used in management buy-outs to provide part or all of the funding, and to provide businesses with the money they need to develop and prosper.

Private equity companies look to make significant returns on their investment to compensate them for the risks involved. Stringent demands will be placed on the board of directors and it will be expected that financial targets will be met on time so that the private equity investor can 'exit' the investment profitably in accordance with a pre-determined schedule, usually between three and five years.

For this reason, a period of private equity investment could be seen as a spell at company boot camp, which although challenging, has positive effects. The results-driven pressure imposed by private equity managers can lead to a significant turnaround in a company's fortunes, including increased profits and benefits for the economy as a whole.

Emma Cotsworth is a second seat trainee in Eversheds' London office.