Private equity is an investment made directly into a company, rather than through a public stock exchange.
Most investors are used to thinking of common stocks as the way to buy into a company. For most investors this is true, since common stock is relatively cheap and easy to buy and sell.
Some investors, however, choose to invest directly into a a company via private equity. They have more money to put to work and, often, these investors are willing to give up simplicity in exchange for a better return.
For instance, a company that is very new and not ready to offer shares to the public might raise money via private equity. A company might need a cash injection to save itself and recapture market share, a process known as a turnaround.
Still other situations include buyouts, where investors band together to purchase control of a company in order to turn it around or, possibly, to break it apart and sell off what’s valuable to other investors.
The powerful attraction of private equity investments is the prospect of control. A private investor often controls the company or at a minimum has a say in key decisions.
Private investors often occupy board seats and can name candidates to management roles.
The downside of private equity is lack of liquidity. The investor cannot easily sell shares and reallocate that capital elsewhere in the market or easily access invested cash.
The other downside is a long holding period. Investors in private equity do not get easily measurable feedback in the form of public share prices. They must trust their ability to vet investment opportunities in advance and keep close tabs on the business as the investment develops.
Large institutional investors such as college endowments and pension funds are common investors in private equity offerings. Some accredited investors, generally people who are already rich, can qualify to invest in private equity.
A successful private equity investment eventually ends in an exit, in which the company finally goes public.
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