What are Private Equity Firms?

Malcolm Tatum

Private equity firms are business organizations that make use of equity securities in order to generate a profit. Generally, the securities utilized by a private equity firm are not traded on a stock exchange. Private equity firms are often involved in buying and selling companies with an eye toward turning a short term profit. However, private equity firms do sometimes engage in buying and selling businesses as part of a long term investment approach.

Businessman with a briefcase
Businessman with a briefcase

It is not unusual for private equity firms to be formed by a group of investors that have a similar vision. The root cause of the establishment of this type of firm may begin with a single common project. As the project begins to yield returns, the partners may look for similar ventures to continue the operation of the firm and keep the profits flowing. Depending on the aims of the partners, the firm may focus on a particular type of business venture, or diversify their interests to include several different types of investment schemes.

While private equity firms may go with any number of investment approaches, there are three private equity investments that tend to be common. First, there is the leveraged buyout. With this approach, the partners use financial leverage to acquire a business from the current set of shareholders and divide the acquired shares among the partners. This is an approach that may be employed when acquiring a company that is financially solvent and current generating a decent about of cash flow.

A second approach used by private equity firms has to do with supplying venture capital to a new business. Unlike buying companies, the venture capital may serve as a means of helping the new company get on its feet and begin to generate substantial revenue at a later date. This type of private equity investment is more long term, as the partners in the firm may not expect to see a return for an extended period of time.

Providing growth capital to established companies who wish to expand or diversify is another approach that may be utilized by private equity firms. As with a venture capital approach, extending growth capital does not involve buying businesses. Instead, the growth capital is provided in exchange for stock in the company or with an understanding that the loan of the capital will be repaid at a specified future date.

As with most financial partnerships, the aim of private equity firms is to generate a return for all parties involved. The operation can be beneficial for everyone. Recipients of the support of the firm have a chance to grow and ultimately become a strong company. The investors who make up the firm benefit from the presence of participating in a group that allows them to pick and choose projects that hold the potential to generate a great deal of wealth for everyone concerned.

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