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A portfolio company is a company that represents one specific investment for an investment firm that specializes in investing in private businesses for the purpose of gaining equity in those businesses or buying them out. All of the companies in which a firm invests represent a firm's portfolio. The investment in a portfolio company may take the form of private equity in established companies or venture capital in companies just starting out. Investment fund managers try to build a portfolio of companies that maximizes profit potential for its investors while limiting risk.
The stock market, in which investors buy and sell shares of publicly owned companies, is just one form of investment opportunity for individuals. Another form of investment comes through large investment firms that devote their funds to privately owned companies in need of capital. These companies often need business capital to fund some new initiative, upgrade equipment, or simply survive. Business investment in these companies usually requires significant capital, but just one lucrative portfolio company can return this capital many times over to investors.
In general, the process by which a portfolio company is targeted is begun by investment firm managers who specialize in researching companies in need of capital and deciding whether such companies have potential for growth. These investment firms generally pool the resources of many investors, who are required to make a significant investment of capital simply to take part in the opportunity. The investment firm then begins to build a portfolio of investments from these funds.
Most investment funds attempt to build portfolios that offer diversification to their clientele. This means that the portfolio companies will be selected from a large range of industries and may represent a wide scope in terms of their market positions. One portfolio company might be a well-established mid-market firm that simply needs a capital boost to get through a rough patch, while another might be a technology start-up with a minimal track record but a great idea that needs capital to be put into action.
By exposing investors to different levels of risk and potential reward, portfolio managers can effectively remove the risk of the investment as a whole. The diversity of the portfolio means that the failure of one single portfolio company, or even a few, can be mitigated by the positive returns from the companies in the portfolio performing well. It should also be noted that companies may be targeted for different reasons, as some are meant to gain equity shares for investors, while others are intended to be bought out completely.
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