Private Equity (PE) and Venture Capital (VC) firms are fund managers that generally invest in companies that are considered to have high growth potential. These companies may be distressed or in need of capital to expand.
In the case of VC, the commercial potential may still only be a concept. PE may also buy part or all of a public company, but this is less common. A wide variety of businesses in various industry sectors benefit from PE and VC investment. The main sectors are life sciences, energy and environment, business and industrial services, consumer services and retail, communications and financial services.
PE and VC inject hundreds of millions of dollars each year into the Australian economy.
PE and VC are considered an “alternative asset class”, meaning they are not a mainstream investment type like listed equities, debt instruments or term deposits. Sources of funding PE and VC firms raise their funding from institutions and, in some cases, high net?worth individuals.
PE investors seek exposure to long?term investments with stable performance returns. VC sits higher on the risk?reward equation. As a result, VC investors are looking for higher reward outcomes to offset the higher risk profile. Australian superannuation (pension) funds are important investors in domestic PE and VC funds, although foreign?sourced funds are increasingly being accessed.
PE and VC fund managers often invest some of their own capital, too. The PE and VC managers of the fund are described as general partners (GPs) because they manage the fund and are liable for its legal debts and obligations. The investors are described as limited partners (LPs) in the fund because their liability for debts and obligations of the fund is limited to the amount of their investment in the fund. LPs are passive investors because they are precluded from getting actively involved in the management of portfolio companies.
Unique VC characteristics
VC firms generally invest in early stage companies, although they also invest in expansion stage businesses (later stage VC). They usually invest in companies that have developed new technologies, systems and processes, rather than established technologies. As a result, VC is a fundamental link in the national innovation system. It provides capital and commercialisation skills to some of the country’s top scientific, technical and entrepreneurial brains, to help make Australian innovation a commercial success.
Without a thriving VC industry, many Australian inventors and entrepreneurs – from biotechnologists through to software developers and industrialists – would be unable to bring their innovations to market. VC is considered a high risk investment because the funding is often at the development phase of a concept that is yet to prove its commercial worth.
The VC’s goal is to grow the company to a point where it can be sold at a profit. Many venture capitalists come to the industry after their own successful careers as scientists, engineers, doctors or entrepreneurs. VC firms generally do not use leverage (i.e. debt) in their transactions, and invest for an average period of seven years.
Unique PE characteristics
PE usually buys into established businesses with growth potential. Some investee companies may be distressed or facing bankruptcy. The areas where PE firms have the greatest impact are with companies needing more management attention, strategic direction and investment capital. PE fund managers become actively involved in the strategic process and management of a company.
PE will finance its acquisitions through a combination of equity and debt. Compared to VC, PE firms have larger investments in fewer companies, and invest for an average period of five years. The greatest gains in enterprise value are achieved by growing the core business and operational revenues.
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