What Is Private Equity and Venture Capital?

What Is Private Equity and Venture Capital?

The definition of Private Equity (PE) is based on two aspects, each related to the two main characteristics of the Private Equity relation:

Private Equity is a source of financing: It is an alternative to other sources of liquidity, (such as a loan or an initial public offering (IPO)) for the
company receiving the financing.

Private Equity is an investment made by a financial institution: Private Equity Investor (PEI) in the equity of a non-listed company (i.e. not a public

Why Companies Need Private Equity And Venture Capital

Why Would a Company Need Private Equity Investment?

Private Equity is based on two aspects:
Private Equity is a source of financing;
And Private Equity is an investment.
… but why would a company need Private Equity? Why should a company let an external investor sit on its board of directors and make managerial decisions?

The venture-backed company wants to enjoy some direct and indirect benefits that a company can exploit when financed by a Private Equity Investor.

  1. Certification Benefit
  2. Network Benefit
  3. Knowledge Benefit
  4. Financial Benefit
  1. The Certification Benefit

    Due to the long screening phase before deciding to invest in a company, if the PEI finally does choose to invest in the venture-backed company, in a way, that confirms the very high quality of the company’s accounts.

    This can give a sign of great health of the company and this high quality can be used as a kind of promotion for the venture-backed company’s brand.
  2. The Network Benefit
    The PEI can give the company a very strong network, in terms of suppliers, customers and banks therefore multiplying its possible contacts.
  3. The Knowledge Benefit

    The PEI can transfer knowledge to the company:
    Soft Knowledge: the capability to manage the business
    Hard Knowledge: the specific-field knowledge of a business, this applies particularly to high-tech or pharmaceutical industries
    With this knowledge, an investor can even carry the company through very hard and difficult steps, such as a merger and acquisition (M&A) process.
    The PEI plays the role of an advisor and mentor.
  4. The Financial Benefit

Private Equity and Venture Capital

The financial benefit is generated through the injection of cash in return for shares of the venture-backed company.

The increase generates the following effect on the cost of capital:

If a company needs at least one of the four benefits, then Private Equity is the only choice; if not, there are other sources of financing, each suitable for the life stage where the company has that specific need.

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