In this article we will consider the four sub asset classes of private equity.Let's work with the European definitions, which differ from the American terminology.The private equity asset class is sub divided into buyouts, growth, venture and mezzanine.The majority of private equity funds will tend to specialise in one of the four, as they have their own specific characteristics.
Venture deals typically involve investing in companies engaged in some form of innovation in a specific sector; for example FinTech, Clean Energy or Software.These companies tend to invest in start ups or early stage companies, which have a real chance of not surviving.Deal sizes in venture range between one and five million euros.The market is fragmented, in the sense that there will be many start ups looking for funding, who need to be identified.Angel investors, that is wealthy private individuals, are also active in this segment.A popular dramatization of venture investments is the “Dragon’s Den” television franchise, in which aspiring entrepreneurs pitch their business idea to a panel of investors.The typical form an investment will take is through ordinary or preferred shares, in which investors may subscribe through multiple rounds of shares issued at different points in time as the company grows and needs more cash to fund its continuing expansion.These shares issues are what is referred to as “Series A, B, C, D” and so on; with each subsequent letter of the alphabet referring to a share issue at a later point in time.It is also common for the founders’ ownership to get diluted down to twenty percent or less over time.Once a venture investment is made, it is usual for the venture investor to get quite involved in the company’s management and operations.This is because as a young company, the management team may need more guidance and support.Often when founders choose a venture investor, they are looking not just for capital, but also a partner who will give them other forms of support, such as advice on operations, introductions to new clients, employees, suppliers and finance providers; the provision of strong corporate governance through their experience as Board members.It is quite common that the professional profile of venture private equity fund managers, includes a lot of operational experience.Examples would be former entrepreneurs, consultants or corporate managers.
Growth deals will involve companies which have been in existence longer and which have already achieved a stable position in their market.What these companies are looking for is resources to scale up their operations, so that they can become more of a leader in their sector.The range of sectors in Growth will include a whole range of economic sectors, instead of just sectors where innovation is occurring as in the case with venture.Let me give you the example of a family owned peanut producer, where the thirty five year old son was taking over from his father; and wanted to build a new plant and move into the production of higher value items like peanut butter.He was ready to give up forty percent of the company to a private equity investor and accepted that it was necessary to build up a management team, instead of his father deciding everything like in the past.So owning sixty per cent of a much bigger cake.
The typical investment size in growth ranges between five million and twenty million Euros.The investment is most commonly a one shot investment or at most involves a single follow on, unlike the multiple rounds of venture.The original shareholders will typically also maintain a larger or even majority stake, unlike many venture founders.As the company develops, it is also possible that further expansion will be fuelled by debt or mezzanine finance, which is beneficial to the equity holder as it will increase their return.Once an investment is made, the growth investor will get involved in supporting the company, but in a less intense way than the venture investor.He will focus more on acting as a kind of in-house consultant and investment banker, looking at high level strategy, corporate governance or making “bolt-on” acquisitions; in which the company grows by acquiring competitors.This is known as a “buy and build” strategy and the growth investor can add a lot of support, in the frequent cases where the existing management lacks experience in making and – just as importantly – integrating acquisitions.The profile of the private equity team will be more mixed than the venture team, with some members with operational backgrounds, and others with more financial and transaction oriented backgrounds.
Our third private equity category is buyouts.These involve the purchase of a larger company that has already achieved prominence in its markets, but which could do with a kind of makeover.Deal sizes in buyouts are typically between twenty and fifty million Euros; to which we must also add the high profile mega deals, which are actually quite few in number, but which generate wide publicity.One important point to note is that these companies do not require much new capital, so the investment is actually used to buy the company from existing shareholders, rather than being put to work in the company as in the case of venture and growth.The main reason that these transactions happen is that the company can simply benefit from a change of ownership.Examples of this can include a family owned company with succession problems, a division of a conglomerate which has lost interest in it, a state owned company being privatised, or a quoted company undervalued by the market.The idea of the buyout is to liberate positive energy in the company, by having a new owner more enthusiastic or rational about owning the company.This energy is often helped along by giving stock options to management which depend on their meeting financial targets.Another key feature of many buyouts is the use of debt, in which case they are referred to as leveraged buyouts.This simply means that the buyout investor buys the company partly with his fund’s money and partly – or even mainly – with borrowed money.So he might borrow four Euros for every Euro he puts in, which would allow him to spend one hundred million on a deal with only twenty million of his own fund’s money.This leveraged feature is not shared by venture or growth investors.Because the company is mature, the profile of the private equity team is mainly financial.Any operational improvements, if needed, are typically outsourced by the buyout manager to external consultants, rather than having such a skill as an in-house competence of the buyout firm.
Our fourth and last private equity subset is mezzanine.Mezzanine funds are funds that invest by using debt rather than equity.They therefore do not become major owners of the companies they invest in, but are rather creditors like banks.Unlike banks, their investment takes place with a form of debt called subordinated debt, which ranks below senior debt and is usually not collateralised.In addition mezzanine investors will have a minor interest in the equity value of the company, as they will usually get a so called “sweetener” which takes the form of equity warrants for perhaps five or ten percent of the company.Mezzanine managers are less involved in the operations of the company they invest in, although they may sometimes have a seat on the board.The background of the team tends to be purely financial.
So what we have described are four distinct private equity sub classes, which have their own distinct ecosystems and characteristics.Venture has a focus on innovative companies, growth looks at a wider range of companies which can be scaled up, buyouts look for mature companies undervalued by their shareholders and mezzanine operates in a kind of specialist niche.
