By: Michelle Wu
Head of Marketing
September 5, 2024
Almost every company eventually reaches a stage where external support becomes essential. This may involve a fresh infusion of capital or external managerial expertise to help the company overcome some developmental challenges or seize some promising opportunities.
Private equity (PE) is a type of investment strategy that specializes in identifying and investing in companies at this stage. Private equity investors bring in not just capital but also strategic guidance, operational expertise, and industry connections that can help drive value creation. For the target companies, the benefits include accelerated growth, enhanced competitive positioning, access to new markets, and much more.
The primary objective of private equity investors is to realize substantial returns on their investments, typically through a successful exit, such as an initial public offering (IPO) or a sale.
Several investment strategies exist within private equity. These strategies can be broadly categorized depending on the growth stage of the target company and the investor’s investment goals.
In this guide, we’ll explore the main types of private equity strategies and give you some useful pointers on how to select the right strategy for your circumstances.
Types of private equity strategies
Venture capital
Venture capital (VC) is a PE strategy focused on providing capital to early-stage companies with substantial growth potential.
These companies are often in the infant stage of development and have innovative ideas or technologies that could disrupt existing markets or create entirely new ones. However, they lack the financial resources and operational infrastructure needed to scale their operations independently.
Venture capital firms step in by providing the necessary capital, along with strategic guidance and industry expertise, to help these startups grow and succeed. In exchange, VCs acquire equity stakes in the companies, positioning themselves to benefit from the potentially explosive growth that successful startups can achieve.
Venture capital’s greatest appeal lies in its potential for high rewards, particularly when investing in groundbreaking tech, revolutionary consumer products, or medical breakthroughs.
But with this high reward potential also comes big risks. Data from various sources show that over 90% of start-up companies fail, with as much as 20% failing in the first year. Failure of a startup company can translate into substantial losses for venture capital investors.
Despite these risks, there are numerous success stories in venture capital. Companies like Apple, Facebook, Uber, and AirBnB have all yielded significant returns for their VC backers.
Growth equity
Unlike venture capital, which seeks companies in their startup phase, growth equity looks to invest in established companies that already have a viable business model, a solid customer base, and recurring revenue streams, but that need capital to take the next big step in their development.
These are companies that have moved beyond the initial startup phase but still have significant growth potential. Growth equity provides capital to drive transformative initiatives, such as expanding operations, developing new products, entering new markets, or making strategic acquisitions.
This private equity strategy offers a good balance between risk and return. Because they invest in more mature companies, growth equity investors can mitigate some of the risks associated with early-stage investments while still enjoying the potential for significant returns.
Silver Lake investment in Alibaba in 2011 and 2012 and Edison investment in Yield Street are great examples of successful growth equity investments.
Buyouts
Buyouts involve acquiring a controlling interest in an established company, often using significant leverage (i.e., debt), hence the term ‘leveraged buyout‘ (LBO).
The primary objective of a buyout is to take control of the company, implement strategic changes, and enhance its value before eventually selling it at a profit.
LBO investors typically target companies that are mature, stable, and generating consistent cash flows but that may be underperforming relative to their potential.
The investors then work closely with the target’s management team to implement strategic changes to improve operational efficiency, optimize financial performance, and drive growth. These changes might include restructuring management, streamlining operations, cutting costs, or entering new markets.
As mentioned, the use of leverage is a key component of the buyout strategy. Financing a portion of the purchase with borrowed money (typically secured by the target’s assets) allows LBO investors to amplify their returns if the investment turns out to be a success.
However, the key risk with LBOs is that the acquired company must generate sufficient cash flow to service the debt while undergoing the transformation process.
Some high-profile examples of leveraged buyouts include Clear Channel in 2006, Hilton Hotels in 2007), and X (formerly Twitter) in 2022.
Private credit
Private credit refers to loans issued by non-bank or nonpublic entities to private companies.
These loans are provided outside the traditional banking system as well as the heavily regulated securities industry. Consequently, private credit investors often have more flexibility in structuring loans to meet the specific needs of the borrower. They can offer terms that might not be available through conventional channels.
Private credit allows lenders to generate income with a lower risk profile and more stable returns, often based on fixed interest payments. That means a predictable cash flow. The tradeoff is that the overall potential return is lower than that of equity investments.
Distressed debt
Distressed debt investing involves buying the debt of private companies that are in financial trouble or on the verge of bankruptcy. These investments are typically made at a significant discount to the debt’s face value, which provides an opportunity for big returns if the company successfully recovers.
Recovery may result from economic improvements or proactive measures such as restructuring or mergers and acquisitions. In some cases, distressed debt investors may convert their debt holdings into equity, gaining control of the company and guiding it through a turnaround.
That said, the risks associated with distressed debt are high. These investments involve companies that are already in precarious financial situations, and there’s no guarantee of recovery. Also, while debt securities have a higher claim than equity in liquidation scenarios, there are several other obligations that are above it, such as tax liabilities. These can exhaust funds from liquidated assets, leaving nothing for distressed debt investors.
Regardless, there have been several notable successes in distressed debt investing. For example, Brookfield Asset Management, a Canadian asset management company, invested in the distressed debt of US shopping mall operator General Growth Properties (GGP) in 2009 and made substantial returns when the latter emerged from bankruptcy a year later.
Impact investing
Impact investing, sometimes referred to as ESG investing, aims to generate positive social or environmental outcomes alongside financial returns.
While most traditional PE investment strategies focus primarily on financial performance, impact investing seeks to create measurable benefits for society while still delivering competitive returns to investors.
It covers a wide range of sectors, including renewable energy, affordable housing, sustainable agriculture, and many more.
Impact investing has witnessed significant growth in recent times, mostly as a result of a broader shift among investors who are increasingly looking to align their investment portfolios with their values.
As awareness of global challenges such as climate change, inequality, and access to healthcare continues to rise, more investors are looking for opportunities to contribute to solutions while also earning financial returns. Impact investing offers an opportunity to do just that.
Infrastructure investing
Infrastructure investing focuses on assets that provide essential facilities or services to society. These assets include utilities (such as water, gas, and electricity), energy (like oil terminals, power plants, pipelines, and solar farms), social infrastructure (such as hospitals and schools), and transportation networks (including railways, airports, and seaports).
Infrastructure projects are typically large-scale and capital-intensive. Private equity firms involved in infrastructure investing often partner with governments or other institutional investors to finance these projects.
These investments are often seen as low risk due to their essential nature. For example, people will always need running water and power, meaning that the entities behind these utilities are likely to generate consistent revenue streams regardless of the economic climate. The chances of these entities going out of business are also low.
What’s more, infrastructure projects enjoy long-term contracts or regulatory frameworks, which provide additional security for investors.
Secondaries
Secondary market transactions involve the buying and selling of existing private equity investments from one investor to another.
For buyers, secondary markets provide a way to gain exposure to mature assets, with more visibility into their performance and potential returns. Additionally, secondaries often come at a discount to their net asset value, providing a huge potential for attractive returns as they move closer to their realization phase.
For sellers, secondaries offer crucial liquidity, enabling earlier portfolio exits, rebalancing, or addressing cash flow needs.
How to select the right private equity investment strategy
As seen, there’s a diverse range of private equity investments available. So how do you choose the right option for you? Here are some useful pointers.
Risk and return alignment
Before you invest, determine your risk tolerance and then align it with your return expectations. For example, venture capital offers the potential for high returns but carries significant risk due to the high failure rate of early-stage companies. Therefore, if you have a lower risk tolerance, growth equity or buyouts might be more appropriate. They offer lower risk while still promising relatively good returns.
Investment horizons
When choosing a PE investment strategy, consider your investment horizon. How long do you plan on keeping your money invested, and when do you envision recouping your investment?
Venture capital typically requires a long-term commitment, often 7-10 years or even longer, to realize returns. Growth equity investments might offer a medium-term horizon, with possible exits in 5-7 years. Buyouts, depending on the exit strategy, could provide returns within a shorter timeframe, especially if the firm is well-positioned for a strategic sale.
Market conditions
The overall economic situation can impact which PE strategy is more appealing. For example, in a thriving economy or during periods of innovation and growth, venture capital and growth equity may be preferable options. Conversely, buyouts may be more enticing in a downturn, where PE investors can acquire undervalued assets and turn them around.
Operational involvement
Another important consideration that can help guide your decision is the amount of involvement in the target you’re willing to undertake.
Venture capital often demands significant hands-on mentoring and strategic guidance. Growth equity investments generally require oversight but less day-to-day involvement, focusing on scaling operations. Buyouts, however, may require substantial operational restructuring and deep engagement.
Choose a strategy that aligns with your capacity and expertise in managing portfolio companies.
Wrapping Up: Get the most out of your private equity investments with Allvue
Private equity offers diverse strategies, each presenting unique opportunities and challenges.
It’s up to individual private equity firms or funds to evaluate these opportunities and risks, as well as their personal circumstances, to determine the best choice.
Whatever private equity strategy you choose, Allvue Systems provides a comprehensive suite of private equity solutions designed to empower you at every stage of the investment process. Whether you are in the deal sourcing, the due diligence, or the portfolio management phase, Allvue provides the tools you need to make data-driven decisions and maximize your investment returns.
Request a demo today to see Allvue’s tool in action.
Sources
Investopedia: 10 Most Famous Leveraged Buyouts. https://www.investopedia.com/articles/markets/111015/10-most-famous-leveraged-buyouts.asp
Pensions & Investments: Silver Lake gains $4.5 billion on Alibaba IPO. https://www.pionline.com/article/20140919/ONLINE/140919806/silver-lake-gains-4-5-billion-on-alibaba-ipo
Edison Partners. Edison Partners Leads $62 Million Investment in YieldStreet https://www.edisonpartners.com/blog/yieldstreet-investment#:~:text=PRINCETON%2C%20NJ—Feb.,the%20digital%20wealth%20management%20platform.
LA Times. Brookfield Asset Management reportedly in talks to buy General Growth Properties. https://www.latimes.com/archives/la-xpm-2010-feb-24-la-fi-mall24-2010feb24-story.html
More About The Author
Michelle Wu
Head of Marketing
Michelle is a dynamic marketing leader with 15+ years of experience in capital markets, fintech, and cybersecurity technology industries. Prior to joining Allvue, Michelle was the Vice President of Product Marketing at SecurityScorecard, a global leader in cybersecurity ratings, and was the Head of Security & Compliance Marketing at Box. Before moving into cybersecurity, she led the Banking & Securities GTM strategy at Intralinks and covered capital markets clients at HSBC. She holds an MSc in Media & Communications from the London School of Economics and a BS in Marketing & Finance from NYU Stern School of Business.
