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.
- Certification Benefit
- Network Benefit
- Knowledge Benefit
- Financial Benefit
- 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.
- 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.
- 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.
- 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.