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EQUITY
PROGRAM
Essentially, equity capital is money that is
invested into a company in exchange for an ownership interest in that company.
Traditionally, equity capital unlike debt is not intended to be repaid according
to a specific schedule and is not secured (or guaranteed) by the company's
assets. Instead, an equity investor (i.e., the individual or entity that
supplies the company with the money) expects that, within a certain time frame,
the ownership percentage she holds will be worth more than the original amount
she invested.
You may be more familiar than you think with the concept of equity capital.
Millions of people are public equity investors because they own shares in large
corporations such as Microsoft and Wal-Mart, companies whose ownership interests
are priced and traded publicly. In Equity Capital Market Landscape, however,
when we say equity capital, we are referring to private equity capital, which
represents money that is invested in private companies, or those that are not
listed on the NYSE or NASDAQ exchanges.
How do you know if equity capital is for your company?
Public equity capital is only for large proven companies, often with hundreds of
millions of dollars in revenues and profits. The opportunities for companies to
secure public equity capital for the first time, or to go public in an IPO, are
extremely limited.
Private equity capital, on the other hand, can be appropriate for fast-growing,
young companies. please note that for those fast-growing, young companies
that have (1) limited capital needs and (2) stable cash flow or a substantial
tangible asset base, debt financing may be a better financing alternative.
Why might debt financing be more appropriate?
At first glance, it may seem like equity is a better deal for a company than
debt, but private equity investors are no fools. In fact, experienced private
equity investors usually make a 25% return on investment (ROI), far more
expensive for a company than the typical debt interest rate of less than 15%.
Additionally, private equity investors know that an equity investment in a
company is much a more risky vehicle for their money than a loan (i.e., debt) to
a company, so there are a number of checks and balances inherent in the
structuring of a private equity investment and the corresponding ownership
interest.
So why does any company seek private equity capital?
Private equity capital can often the only option for a start-up company with
high growth potential. For example, TechForCash, a start-up software company,
anticipates product development expenditures of $1 million during the two years
of its life. In its third year, fourth, and fifth years, it expects to make $1
million, $2 million, and $4 million, respectively. Despite this remarkable
growth potential, TechForCash would probably not be able to get a loan to
finance its launch. However, if TechForCash has a strong business plan, an
impressive management team, a pilot product, and a couple of clients, a private
equity investor may be willing give the company $1 million in development
capital, in exchange for, say, 25% ownership in the company.
What are the sources of private equity capital?
These corporate venturing programs may be loosely organized programs affiliated
with existing business development programs or may be self-contained entities
with a strategic charter and mission to make investments congruent with the
parent strategic mission. There are some venture firms that specialize in
advising, consulting and managing a corporations venturing program.
Angels In the early days of venture capital investment, in the 1950s and 1960s,
individual investors were the archetypal venture investor. While this type of
individual investment did not totally disappear, the modern venture firm emerged
as the dominant venture investment vehicle. However, in the last few years,
individuals have again become a potent and increasingly larger part of the early
stage start-up venture life cycle. These "angel investors" will mentor a company
and provide needed capital and expertise to help develop companies. Angel
investors may either be wealthy people with management expertise or retired
business men and women who seek the opportunity for first-hand business
development.
Venture Capital Firms Venture capital firms are pools of capital, typically
organized as a limited partnership, that invest in companies that represent the
opportunity for a high rate of return within five to seven years. The venture
capitalist may look at several hundred investment opportunities before investing
in only a few selected companies with favorable investment opportunities. Far
from being simply passive financiers, venture capitalists foster growth in
companies through their involvement in the management, strategic marketing and
planning of their investee companies. They are entrepreneurs first and
financiers second.
Leveraged Buyout Firms Leveraged buyout firms specialize in helping
entrepreneurs to finance the purchase of established companies. The approach of
such firms is to provide a management team with enough equity to make a small
down payment on the purchase of a business, and then to pay the rest of the
purchase price with borrowed money. The assets of the company are used as
collateral for the loans, and the cash flow of the company is used to pay off
the debt. Because the acquired company itself is paying the freight for its own
acquisition, these investments were originally known as "boot-strap" deals.
Eventually they became known as leveraged buyouts, or management buyouts.
Large Corporations One form of investing that was popular in the 1980s and is
again very popular is corporate venturing. This is usually called "direct
investing" in portfolio companies by venture capital programs or subsidiaries of
non-financial corporations. These investment vehicles seek to find qualified
investment opportunities that are congruent with the parent company's strategic
technology or that provide synergy or cost savings.
What is the private equity market like right now?
The typical distinction between corporate venturing and other types of venture
investment vehicles is that corporate venturing is usually performed with
corporate strategic objectives in mind while other venture investment vehicles
typically have investment return or financial objectives as their primary goal.
This may be a generalization as corporate venture programs are not immune to
financial considerations, but the distinction can be made. The other distinction
of corporate venture programs is that they usually invest their parents' capital
while other venture investment vehicles invest outside investors' capital.
Financial Polis will market to its network of equity investors to obtain your
financial goals.
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