The stock market, also known as the securities market, is a platform where investors trade in publicly listed securities. However, all companies are not publicly listed and they also require capital to grow, and they obtain funding through the private equity market.
Before making their ownership public, companies often seek investors who are willing to support their growth in exchange for equity. These investors carefully evaluate key factors such as annual sales, product marketability, profit margins, and equity distribution before making investment decisions.
In this blog, we will provide comprehensive information about the types, investment strategies, risks and benefits associated with the private equity market.
What is Private Equity Market
The private equity market is a platform where unlisted private companies reach out to probable investors hoping that they would invest in their company in exchange for a certain percentage of their equity. These investors contribute capital based on the company’s current valuation.
Investors get a return on their capital investment when the company makes progress in the future. With Progress, its valuation increases too and they benefit proportionally based on their equity stake.
Private companies look for this kind of funding because, unlike loans, it does not impose repayment obligations, reducing financial risk for the owners.
Key Differences of Private Equity Market and Public Equity Market
The private equity market and public equity market have their own features and differences. Here is a list of differences among them.
| Features | Private Equity Market | Public Equity Market |
| Ownership | In this type of market, companies are under the ownership of institutional investors, private investors and firms. | In this type of market, companies are owned by retail investors and general people. |
| Availability | These are available to institutional investors and individuals with high net worth. | Everybody who can pay for at least one share of a company can become an investor. |
| Regulatory obligations | Faces lower regulatory scrutiny with limited disclosure requirements. | Subject to strict regulations, requiring full disclosure of financial reports and decisions. |
| Valuation | Company valuation is done by the process of negotiation based on the company’s past performances and future prospects. This step can be a hassle for both parties. | Valuation follows a standardised process based on total company assets minus liabilities, with no negotiation involved. |
| Liquidity | Low liquidity; investments are long-term with a time-consuming liquidation process. | Highly liquid; shares can be bought and sold daily. |
| Control and authority | Investors take active participation in management and decision-making as they provide significant funds. | Investors have limited control; they can vote on proposals, but decisions are made by management and the Board of Directors. |
| Risk | High risk due to long holding periods and slow liquidation. | Faces market fluctuation risks but offers fast liquidation. |
Types of Investments in The Private Equity Market
The PE market is the main source of funds for a private company. There are many money-earning opportunities for investors in this market and a lot of high-authority people invest in this market. Here are some of them:
-
Growth Capital Investment
Growth capital investors provide funding to well-established private companies looking to expand operations, boost sales, enhance marketing efforts, or meet other financial needs.
These investments support a company’s development while minimising risk, as they are typically made in profitable and growing businesses. However, negotiations can make these investments costly.
-
Venture Capitalist Investment
Venture capitalists fund a company at its early stage when the valuation is not that high. However, they have high growth potential. In addition to funding, they offer expertise and industry connections to help startups evolve into profitable organisations. However, decision-making largely remains with the company’s founders.
While this investment carries significant risk due to the uncertainties of early-stage businesses, it offers a lower entry cost for equity stakes.
-
Specialised Investment
Specialised investors focus on a few specific industries with high growth potential. These investors focus on specific high-growth industries such as technology, healthcare, real estate, and architecture.
-
Buyout Funds
These investors invest a considerable amount of funds to acquire a significant or controlling stake in a company. They acquire substantial authority over the company’s operations, allowing them to implement strategic changes that enhance performance and maximise returns.
-
Pension Funds
Public pension funds have increasingly entered the private equity market, seeking higher returns by investing in fast-growing private companies. These investments help pension funds generate long-term value for their beneficiaries.
-
Secondary Investments
Secondary investors purchase equity in private companies from existing investors, providing liquidity in the market. This type of investment gained popularity in 2021, as it allows investors to enter or exit positions without waiting for an initial public offering (IPO) or other major liquidity events.
Top Strategies to Invest in the Private Equity Market
Investors continuously refine their techniques to maximise returns in the private equity market. Here are a few most effective investment strategies.
-
Growth
This strategy involves investing in exchange for a minority stake in a company rather than acquiring a controlling interest. This strategy does not involve debt financing, funding is provided purely in exchange for equity.
Growth investing sits between Venture Capital (VC) and traditional Private Equity (PE), focusing on scaling businesses without adding financial strain. Investors often introduce revenue-generating strategies to optimise operations while minimising debt burdens.
-
Buyout
In this strategy, an investor buys more than half of a company’s shares in exchange for equity and debt.
By gaining control, investors tend to work their expertise to expand operations, drive efficiency, and increase profitability. Their goal is to stabilise revenue streams and reduce the burden of debt payment.
-
Mezzanine
Mezzanine is a unique investment strategy in the private equity market. Investors provide capital in the form of debt while securing an option to convert it into equity at a predetermined value.
During the time of investment, they attach warrants that allow investors the ability to acquire equity ownership while still holding a debt position. This flexible structure allows investors to benefit from both fixed returns and potential equity appreciation.
Risks and Opportunities in the Private Equity Market
There are both risks and corresponding benefits involved while investing in any market. Here is a list of risks and benefits in the private equity market.
| Features | Opportunities | Risks |
| Management | Investors have an active influence on management and crucial decision-making, fostering trust in the company. | Over-interruption of investors might cause problems due to differences in opinion, leading to slow decision-making. |
| Return on investment | High potential for substantial profits as companies grow, aided by the expertise of high-net-worth investors. | Risk of investing in a failing company, which could result in a total loss of capital. |
| Value building | Companies can expand operations and increase sales, leading to greater profitability. | If expansion efforts fail, the investment could become a complete loss. |
| Flexibility | Investors have the flexibility to choose the way they want to provide funds, be it for equity, debt or both. | Lacks the flexibility to make the investment liquid in time of need. |
| Connections | New companies can utilise their investor’s connections and networks for their expansion process. | Becoming overly dependent on investor’s connections might lead to losing authority and independence. |
| Risk | Companies face minimal liability when raising funds through equity, allowing them to focus on growth without debt pressure. | Equity is a crucial asset, and poor negotiation can result in significant long-term disadvantages. |
| Capital diversification | The primary equity market allows investors to gain ownership stakes, which can be a valuable long-term asset. | It takes a lot of funds to invest in a company and buy a certain percentage of it. This causes a lack of diversification and boosts the risk of total loss. |
Final Thoughts
The private equity market has proved to be a beneficial investment platform for both investors and private companies. It helps companies to raise funds without falling under regulatory obligations.
For investors, while it provides high returns, strategic growth, and flexible investment options, it also comes with risks such as illiquidity, management conflicts, and capital concentration. Understanding these factors and adopting the right investment strategies can help investors navigate the market successfully.
If you are starting your investment journey, Torus Digital provides a streamlined Demat account opening account. Our 3-in-1 account integrates banking and investments for a hassle-free experience.
What are you waiting for? Start investing right now!
