PRIVATE EQUITY

Private equity, in finance, is an asset class consisting of equity securities in operating

companies that are not publicly traded on a stock exchange. Investments in private equity
most often involve either an investment of capital into an operating company or the
acquisition of an operating company. Capital for private equity is raised primarily from
institutional investors. There is a wide array of types and styles of private equity and the
term private equity has different connotations in different countries.[1]

Among the most common investment strategies in private equity include leveraged
buyouts, venture capital, growth capital, distressed investments and mezzanine capital. In
a typical leveraged buyout transaction, the private equity firm buys majority control of an
existing or mature firm. This is distinct from a venture capital or growth capital
investment, in which the private equity firm typically invests in young or emerging
companies, and rarely obtain majority control.

• 1 Leveraged buyout
• 2 Venture capital
• 3 Growth capital
• 4 Distressed and Special Situations
• 5 Mezzanine capital
• 6 Secondaries
• 7 Other strategies
• 8 History and development
o 8.1 Early history and the development of venture capital
o 8.2 Origins of the leveraged buyout
o 8.3 Private equity in the 1980s
o 8.4 Age of the mega-buyout 2005-2007
• 9 Investments in private equity
• 10 Liquidity in the private equity market
• 11 Private equity firms
• 12 Private equity funds
o 12.1 Size of the industry - Investment activity
o 12.2 Size of the industry - Fundraising activity
o 12.3 Private equity fund performance
• 13 See also
o 13.1 Organizations
• 14 Notes
• 15 References

Leveraged buyout

Main article: Leveraged buyout

Diagram of the basic structure of a generic leveraged buyout transaction

Leveraged buyout, LBO or Buyout refers to a strategy of making equity investments as
part of a transaction in which a company, business unit or business assets is acquired
from the current shareholders typically with the use of financial leverage. The companies
involved in these transactions are typically mature and generate operating cash flows.[2]

Leveraged buyouts involve a financial sponsor agreeing to an acquisition without itself

committing all the capital required for the acquisition. To do this, the financial sponsor
will raise acquisition debt which ultimately looks to the cash flows of the acquisition
target to make interest and principal payments.[3] Acquisition debt in an LBO is often
non-recourse to the financial sponsor and has no claim on other investment managed by
the financial sponsor. Therefore, an LBO transaction's financial structure is particularly
attractive to a fund's limited partners, allowing them the benefits of leverage but greatly
limiting the degree of recourse of that leverage. This kind of financing structure leverage
benefits an LBO's financial sponsor in two ways: (1) the investor itself only needs to
provide a fraction of the capital for the acquisition, and (2) the returns to the investor will
be enhanced (as long as the return on assets exceeds the cost of the debt).[4]

As a percentage of the purchase price for a leverage buyout target, the amount of debt
used to finance a transaction varies according the financial condition and history of the
acquisition target, market conditions, the willingness of lenders to extend credit (both to
the LBO's financial sponsors and the company to be acquired) as well as the interest costs
and the ability of the company to cover those costs. Historically the debt portion of a
LBO will range from 60%-90% of the purchase price, although during certain periods the
the debt ratio can be higher or lower than the historical averages.[5] Between 2000-2005
debt averaged between 59.4% and 67.9% of total purchase price for LBOs in the United
States.[6]

[edit] Venture capital

Main article: Venture capital

Venture capital[7] is a broad subcategory of private equity that refers to equity

investments made, typically in less mature companies, for the launch, early development,
or expansion of a business. Venture investment is most often found in the application of
new technology, new marketing concepts and new products that have yet to be proven.[8]
[9]

Venture capital is often sub-divided by the stage of development of the company ranging
from early stage capital used for the launch of start-up companies to late stage and
growth capital that is often used to fund expansion of existing business that are
generating revenue but may not yet be profitable or generating cash flow to fund future
growth.[10]

Entrepreneurs often develop products and ideas that require substantial capital during the
formative stages of their companies' life cycles. Many entrepreneurs do not have
sufficient funds to finance projects themselves, and they must therefore seek outside
financing.[11] The venture capitalist's need to deliver high returns to compensate for the
risk of these investments makes venture funding an expensive capital source for
companies. Venture capital is most suitable for businesses with large up-front capital
requirements which cannot be financed by cheaper alternatives such as debt. Although
venture capital is often most closely associated with fast-growing technology and
biotechnology fields, venture funding has been used for other more traditional businesses.
[8][12]

[edit] Growth capital

Main article: Growth capital

Growth capital refers to equity investments, most often minority investments, in

relatively mature companies that are looking for capital to expand or restructure
operations, enter new markets or finance a major acquisition without a change of control
of the business.[citation needed]

Companies that seek growth capital will often do so in order to finance a transformational
event in their life cycle. These companies are likely to be more mature than venture
capital funded companies, able to generate revenue and operating profits but unable to
generate sufficient cash to fund major expansions, acquisitions or other investments. The
primary owner of the company may not be willing to take the financial risk alone. By
selling part of the company to private equity, the owner can take out some value and
share the risk of growth with partners.[13] Capital can also be used to effect a restructuring
of a company's balance sheet, particularly to reduce the amount of leverage (or debt) the
company has on its balance sheet.[14] A Private investment in public equity, or PIPEs,
refer to a form of growth capital investment made into a publicly traded company. PIPE
investments are typically made in the form of a convertible or preferred security that is
unregistered for a certain period of time.[15][16] The Registered Direct, or RD, is another
common financing vehicle used for growth capital. A registered direct is similar to a
PIPE but is instead sold as a registered security.

[edit] Distressed and Special Situations

Main article: Distressed securities

Distressed or Special Situations is a broad category referring to investments in equity or

debt securities of financially stressed companies.[17][18][19] The "distressed" category
encompasses two broad sub-strategies including:

• "Distressed-to-Control" or "Loan-to-Own" strategies where the investor acquires

debt securities in the hopes of emerging from a corporate restructuring in control
of the company's equity;[20]
• "Special Situations" or "Turnaround" strategies where an investor will provide
debt and equity investments, often "rescue financing" to companies undergoing
operational or financial challenges.[21]
In addition to these private equity strategies, hedge funds employ a variety of distressed
investment strategies including the active trading of loans and bonds issued by distressed
companies.

[edit] Mezzanine capital

Main article: Mezzanine capital

Mezzanine capital refers to subordinated debt or preferred equity securities that often
represent the most junior portion of a company's capital structure that is senior to the
company's common equity. This form of financing is often used by private equity
investors to reduce the amount of equity capital required to finance a leveraged buyout or
major expansion. Mezzanine capital, which is often used by smaller companies that are
unable to access the high yield market, allows such companies to borrow additional
capital beyond the levels that traditional lenders are willing to provide through bank
loans.[22] In compensation for the increased risk, mezzanine debt holders require a higher
return for their investment than secured or other more senior lenders.[23][24]

[edit] Secondaries

Main article: Private equity secondaries

Secondary investments refer to investments made in existing private equity assets.

These transactions can involve the sale of private equity fund interests or portfolios of
direct investments in privately held companies through the purchase of these investments
from existing institutional investors.[25] By its nature, the private equity asset class is
illiquid, intended to be a long-term investment for buy-and-hold investors. Secondary
investments provide institutional investors with the ability to improve vintage
diversification, particularly for investors that are new to the asset class. Secondaries also
typically experience a different cash flow profile, diminishing the j-curve effect of
investing in new private equity funds.[26][27] Often investments in secondaries are made
through third party fund vehicle, structured similar to a fund of funds although many
large institutional investors have purchased private equity fund interests through
secondary transactions.[28] Sellers of private equity fund investments sell not only the
investments in the fund but also their remaining unfunded commitments to the funds.

[edit] Other strategies

Other strategies that can be considered private equity or a close adjacent market include:

• Real Estate: in the context of private equity this will typically refer to the riskier
end of the investment spectrum including "value added" and opportunity funds
where the investments often more closely resemble leveraged buyouts than
traditional real estate investments. Certain investors in private equity consider real
estate to be a separate asset class.
 • Infrastructure: investments in various public works (e.g., bridges, tunnels, toll
roads, airports, public transportation and other public works) that are made
typically as part of a privatization initiative on the part of a government entity.[29]
[30][31]

• Energy and Power: investments in a wide variety of companies (rather than

assets) engaged in the production and sale of energy, including fuel extraction,
manufacturing, refining and distribution (Energy) or companies engaged in the
production or transmission of electrical power (Power).

• Merchant banking: negotiated private equity investment by financial institutions

in the unregistered securities of either privately or publicly held companies.[32]

[edit] History and development

History of private equity
and venture capital

Early history
(Origins of modern private equity)
•
The 1980s
(LBO boom)
•
The 1990s
(LBO bust and the VC bubble)
•
The 2000s
(Dot-com bubble to the credit crunch)
v•d•e
Main article: History of private equity and venture capital

[edit] Early history and the development of venture capital

Main articles: History of private equity and venture capital and Early history of private
equity
The seeds of the US private equity industry were planted in 1946 with the founding of
two venture capital firms: American Research and Development Corporation (ARDC)
and J.H. Whitney & Company.[33] Before World War II, venture capital investments
(originally known as "development capital") were primarily the domain of wealthy
individuals and families. ARDC was founded by Georges Doriot, the "father of venture
capitalism"[34] and founder of INSEAD, with capital raised from institutional investors, to
encourage private sector investments in businesses run by soldiers who were returning
from World War II. ARDC is credited with the first major venture capital success story
when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC) would be
valued at over $355 million after the company's initial public offering in 1968
(representing a return of over 500 times on its investment and an annualized rate of return
of 101%).[35] It is commonly noted that the first venture-backed startup is Fairchild
Semiconductor (which produced the first commercially practicable integrated circuit),
funded in 1959 by what would later become Venrock Associates.[36]

[edit] Origins of the leveraged buyout

Main articles: History of private equity and venture capital and Early history of private
equity

The first leveraged buyout may have been the purchase by McLean Industries, Inc. of
Pan-Atlantic Steamship Company in January 1955 and Waterman Steamship Corporation
in May 1955[37] Under the terms of that transaction, McLean borrowed $42 million and
raised an additional $7 million through an issue of preferred stock. When the deal closed,
$20 million of Waterman cash and assets were used to retire $20 million of the loan debt.
[38]
Similar to the approach employed in the McLean transaction, the use of publicly
traded holding companies as investment vehicles to acquire portfolios of investments in
corporate assets was a relatively new trend in the 1960s popularized by the likes of
Warren Buffett (Berkshire Hathaway) and Victor Posner (DWG Corporation) and later
adopted by Nelson Peltz (Triarc), Saul Steinberg (Reliance Insurance) and Gerry
Schwartz (Onex Corporation). These investment vehicles would utilize a number of the
same tactics and target the same type of companies as more traditional leveraged buyouts
and in many ways could be considered a forerunner of the later private equity firms. In
fact it is Posner who is often credited with coining the term "leveraged buyout" or
"LBO"[39]

The leveraged buyout boom of the 1980s was conceived by a number of corporate
financiers, most notably Jerome Kohlberg, Jr. and later his protégé Henry Kravis.
Working for Bear Stearns at the time, Kohlberg and Kravis along with Kravis' cousin
George Roberts began a series of what they described as "bootstrap" investments. Many
of these companies lacked a viable or attractive exit for their founders as they were too
small to be taken public and the founders were reluctant to sell out to competitors and so
a sale to a financial buyer could prove attractive. Their acquisition of Orkin
Exterminating Company in 1964 is among the first significant leveraged buyout
transactions.[40]. In the following years the three Bear Stearns bankers would complete a
series of buyouts including Stern Metals (1965), Incom (a division of Rockwood
International, 1971), Cobblers Industries (1971), and Boren Clay (1973) as well as
Thompson Wire, Eagle Motors and Barrows through their investment in Stern Metals. [41]
By 1976, tensions had built up between Bear Stearns and Kohlberg, Kravis and Roberts
leading to their departure and the formation of Kohlberg Kravis Roberts in that year.

[edit] Private equity in the 1980s

Main articles: History of private equity and venture capital and Private equity in the
1980s

In January 1982, former United States Secretary of the Treasury William Simon and a
group of investors acquired Gibson Greetings, a producer of greeting cards, for $80
million, of which only $1 million was rumored to have been contributed by the investors.
By mid-1983, just sixteen months after the original deal, Gibson completed a $290
million IPO and Simon made approximately $66 million.[42] The success of the Gibson
Greetings investment attracted the attention of the wider media to the nascent boom in
leveraged buyouts. Between 1979 and 1989, it was estimated that there were over 2,000
leveraged buyouts valued in excess of $250 million[43]

During the 1980s, constituencies within acquired companies and the media ascribed the
"corporate raid" label to many private equity investments, particularly those that featured
a hostile takeover of the company, perceived asset stripping, major layoffs or other
significant corporate restructuring activities. Among the most notable investors to be
labeled corporate raiders in the 1980s included Carl Icahn, Victor Posner, Nelson Peltz,
Robert M. Bass, T. Boone Pickens, Harold Clark Simmons, Kirk Kerkorian, Sir James
Goldsmith, Saul Steinberg and Asher Edelman. Carl Icahn developed a reputation as a
ruthless corporate raider after his hostile takeover of TWA in 1985.[44][45] Many of the
corporate raiders were onetime clients of Michael Milken, whose investment banking
firm, Drexel Burnham Lambert helped raise blind pools of capital with which corporate
raiders could make a legitimate attempt to take over a company and provided high-yield
debt financing of the buyouts.

One of the final major buyouts of the 1980s proved to be its most ambitious and marked
both a high water mark and a sign of the beginning of the end of the boom that had begun
nearly a decade earlier. In 1989, KKR closed in on a $31.1 billion takeover of RJR
Nabisco. It was, at that time and for over 17 years, the largest leverage buyout in history.
The event was chronicled in the book (and later the movie), Barbarians at the Gate: The
Fall of RJR Nabisco. KKR would eventually prevail in acquiring RJR Nabisco at $109
per share, marking a dramatic increase from the original announcement that Shearson
Lehman Hutton would take RJR Nabisco private at $75 per share. A fierce series of
negotiations and horse-trading ensued which pitted KKR against Shearson Lehman
Hutton and later Forstmann Little & Co. Many of the major banking players of the day,
including Morgan Stanley, Goldman Sachs, Salomon Brothers, and Merrill Lynch were
actively involved in advising and financing the parties. After Shearson Lehman's original
bid, KKR quickly introduced a tender offer to obtain RJR Nabisco for $90 per share—a
price that enabled it to proceed without the approval of RJR Nabisco's management.
RJR's management team, working with Shearson Lehman and Salomon Brothers,
submitted a bid of $112, a figure they felt certain would enable them to outflank any
response by Kravis's team. KKR's final bid of $109, while a lower dollar figure, was
ultimately accepted by the board of directors of RJR Nabisco.[46] At $31.1 billion of
transaction value, RJR Nabisco was by far the largest leveraged buyouts in history. In
2006 and 2007, a number of leveraged buyout transactions were completed that for the
first time surpassed the RJR Nabisco leveraged buyout in terms of nominal purchase
price. However, adjusted for inflation, none of the leveraged buyouts of the 2006–2007
period would surpass RJR Nabisco. By the end of the 1980s the excesses of the buyout
market were beginning to show, with the bankruptcy of several large buyouts including
Robert Campeau's 1988 buyout of Federated Department Stores, the 1986 buyout of the
Revco drug stores, Walter Industries, FEB Trucking and Eaton Leonard. Additionally,
the RJR Nabisco deal was showing signs of strain, leading to a recapitalization in 1990
that involved the contribution of $1.7 billion of new equity from KKR.[47]

Drexel Burnham Lambert was the investment bank most responsible for the boom in
private equity during the 1980s due to its leadership in the issuance of high-yield debt.

Drexel reached an agreement with the government in which it pleaded nolo contendere
(no contest) to six felonies – three counts of stock parking and three counts of stock
manipulation.[48] It also agreed to pay a fine of $650 million – at the time, the largest fine
ever levied under securities laws. Milken left the firm after his own indictment in March
1989.[49][50] On February 13, 1990 after being advised by United States Secretary of the
Treasury Nicholas F. Brady, the U.S. Securities and Exchange Commission (SEC), the
New York Stock Exchange and the Federal Reserve, Drexel Burnham Lambert officially
filed for Chapter 11 bankruptcy protection.[49]

[edit] Age of the mega-buyout 2005-2007

Main articles: History of private equity and venture capital and Private equity in the 21st
century

The combination of decreasing interest rates, loosening lending standards and regulatory
changes for publicly traded companies (specifically the Sarbanes-Oxley Act) would set
the stage for the largest boom private equity had seen. Marked by the buyout of Dex
Media in 2002, large multi-billion dollar U.S. buyouts could once again obtain significant
high yield debt financing and larger transactions could be completed. By 2004 and 2005,
major buyouts were once again becoming common, including the acquisitions of Toys
"R" Us[51], The Hertz Corporation [52][53], Metro-Goldwyn-Mayer[54] and SunGard[55] in
2005.

As 2005 ended and 2006 began, new "largest buyout" records were set and surpassed
several times with nine of the top ten buyouts at the end of 2007 having been announced
in an 18-month window from the beginning of 2006 through the middle of 2007. In 2006,
private equity firms bought 654 U.S. companies for $375 billion, representing 18 times
the level of transactions closed in 2003.[56] Additionally, U.S. based private equity firms
raised $215.4 billion in investor commitments to 322 funds, surpassing the previous
record set in 2000 by 22% and 33% higher than the 2005 fundraising total[57] The
following year, despite the onset of turmoil in the credit markets in the summer, saw yet
another record year of fundraising with $302 billion of investor commitments to 415
funds[58] Among the mega-buyouts completed during the 2006 to 2007 boom were:
Equity Office Properties, HCA[59], Alliance Boots[60] and TXU[61].

In July 2007, turmoil that had been affecting the mortgage markets, spilled over into the
leveraged finance and high-yield debt markets.[62][63] The markets had been highly robust
during the first six months of 2007, with highly issuer friendly developments including
PIK and PIK Toggle (interest is "Payable In Kind") and covenant light debt widely
available to finance large leveraged buyouts. July and August saw a notable slowdown in
issuance levels in the high yield and leveraged loan markets with few issuers accessing
the market. Uncertain market conditions led to a significant widening of yield spreads,
which coupled with the typical summer slowdown led many companies and investment
banks to put their plans to issue debt on hold until the autumn. However, the expected
rebound in the market after Labor Day 2007 did not materialize and the lack of market
confidence prevented deals from pricing. By the end of September, the full extent of the
credit situation became obvious as major lenders including Citigroup and UBS AG
announced major writedowns due to credit losses. The leveraged finance markets came to
a near standstill.[64] As 2007 ended and 2008 began, it was clear that lending standards
had tightened and the era of "mega-buyouts" had come to an end. Nevertheless, private
equity continues to be a large and active asset class and the private equity firms, with
hundreds of billions of dollars of committed capital from investors are looking to deploy
capital in new and different transactions.

[edit] Investments in private equity

Diagram of the structure of a generic private equity fund

Although the capital for private equity originally came from individual investors or
corporations, in the 1970s, private equity became an asset class in which various
institutional investors allocated capital in the hopes of achieving risk adjusted returns that
exceed those possible in the public equity markets. For most institutional investors,
private equity investments are made as part of a broad asset allocation that includes
traditional assets (e.g., public equity and bonds) and other alternative assets (e.g., hedge
funds, real estate, commodities).

Most institutional investors do not invest directly in privately held companies, lacking the
expertise and resources necessary to structure and monitor the investment. Instead,
institutional investors will invest indirectly through a private equity fund. Certain
institutional investors have the scale necessary to develop a diversified portfolio of
private equity funds themselves, while others will invest through a fund of funds to allow
a portfolio more diversified than one a single investor could construct.
Returns on private equity investments are created through one or a combination of three
factors that include: debt repayment or cash accumulation through cash flows from
operations, operational improvements that increase earnings over the life of the
investment and multiple expansion, selling the business for a higher multiple of earnings
than was originally paid. A key component of private equity as an asset class for
institutional investors is that investments are typically realized after some period of time,
which will vary depending on the investment strategy. Private equity investments are
typically realized through one of the following avenues:

• an Initial Public Offering (IPO) - shares of the company are offered to the public,
typically providing a partial immediate realization to the financial sponsor as well
as a public market into which it can later sell additional shares;
• a merger or acquisition - the company is sold for either cash or shares in another
company;
• a Recapitalization - cash is distributed to the shareholders (in this case the
financial sponsor) and its private equity funds either from cash flow generated by
the company or through raising debt or other securities to fund the distribution.

[edit] Liquidity in the private equity market

Diagram of a simple secondary market transfer of a limited partnership fund interest. The
buyer exchanges a single cash payment to the seller for both the investments in the fund
plus any unfunded commitments to the fund.
Main article: Private equity secondary market

The private equity secondary market (also often called private equity secondaries) refers
to the buying and selling of pre-existing investor commitments to private equity and other
alternative investment funds. Sellers of private equity investments sell not only the
investments in the fund but also their remaining unfunded commitments to the funds. By
its nature, the private equity asset class is illiquid, intended to be a long-term investment
for buy-and-hold investors. For the vast majority of private equity investments, there is
no listed public market; however, there is a robust and maturing secondary market
available for sellers of private equity assets.

Increasingly, secondaries are considered a distinct asset class with a cash flow profile that
is not correlated with other private equity investments. As a result, investors are
allocating capital to secondary investments to diversify their private equity programs.
Driven by strong demand for private equity exposure, a significant amount of capital has
been committed to secondary investments from investors looking to increase and
diversify their private equity exposure.

Investors seeking access to private equity have been restricted to investments with
structural impediments such as long lock-up periods, lack of transparency, unlimited
leverage, concentrated holdings of illiquid securities and high investment minimums.
Secondary transactions can be generally split into two basic categories:

• Sale of Limited Partnership Interests - The most common secondary

transaction, this category includes the sale of an investor's interest in a private
equity fund or portfolio of interests in various funds through the transfer of the
investor's limited partnership interest in the fund(s). Nearly all types of private
equity funds (e.g., including buyout, growth equity, venture capital, mezzanine,
distressed and real estate) can be sold in the secondary market. The transfer of the
limited partnership interest typically will allow the investor to receive some
liquidity for the funded investments as well as a release from any remaining
unfunded obligations to the fund.

• Sale of Direct Interests – Secondary Directs or Synthetic secondaries, this

category refers to the sale of portfolios of direct investments in operating
companies, rather than limited partnership interests in investment funds. These
portfolios historically have originated from either corporate development
programs or large financial institutions.

[edit] Private equity firms

Main articles: Private equity firm and List of private equity firms

According to an updated 2009 ranking created by industry magazine Private Equity

International[65] (published by PEI Media called the PEI 300), the largest private equity
firm in the world today is TPG, based on the amount of private equity direct-investment
capital raised over a five-year window. As ranked by the PEI 300, the 10 largest private
equity firms in the world are:

1. TPG
2. Goldman Sachs Capital Partners
3. The Carlyle Group
4. Kohlberg Kravis Roberts
5. Apollo Global Management
6. Bain Capital
7. CVC Capital Partners
8. The Blackstone Group
9. Warburg Pincus
10. Apax Partners

Because private equity firms are continuously in the process of raising, investing and
distributing their private equity funds, capital raised can often be the easiest to measure.
Other metrics can include the total value of companies purchased by a firm or an estimate
of the size of a firm's active portfolio plus capital available for new investments. As with
any list that focuses on size, the list does not provide any indication as to relative
investment performance of these funds or managers.
Additionally, Preqin (formerly known as Private Equity Intelligence), an independent
data provider, ranks the 25 largest private equity investment managers. Among the larger
firms in that ranking were AlpInvest Partners, AXA Private Equity, AIG Investments,
Goldman Sachs Private Equity Group and Pantheon Ventures. The European Private
Equity and Venture Capital Association ("EVCA") publishes a yearbook which analyses
industry trends derived from data disclosed by over 1, 300 European private equity funds.

[edit] Private equity funds

Main article: Private equity fund
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Please help improve this article by adding reliable references. Unsourced material may be challenged
and removed. (August 2009)

Private equity fundraising refers to the action of private equity firms seeking capital from
investors for their funds. Typically an investor will invest in a specific fund managed by a
firm, becoming a limited partner in the fund, rather than an investor in the firm itself. As
a result, an investor will only benefit from investments made by a firm where the
investment is made from the specific fund in which it has invested.

• Fund of funds. These are private equity funds that invest in other private equity
funds in order to provide investors with a lower risk product through exposure to
a large number of vehicles often of different type and regional focus. Fund of
funds accounted for 14% of global commitments made to private equity funds in
2006 according to Preqin ltd (formerly known as Private Equity Intelligence)

• Individuals with substantial net worth. Substantial net worth is often required of
investors by the law, since private equity funds are generally less regulated than
ordinary mutual funds. For example in the US, most funds require potential
investors to qualify as accredited investors, which requires $1 million of net
worth, $200,000 of individual income, or $300,000 of joint income (with spouse)
for two documented years and an expectation that such income level will
continue.

As fundraising has grown over the past few years, so too has the number of investors in
the average fund. In 2004 there were 26 investors in the average private equity fund, this
figure has now grown to 42 according to Preqin ltd. (formerly known as Private Equity
Intelligence).

The managers of private equity funds will also invest in their own vehicles, typically
providing between 1–5% of the overall capital.

Often private equity fund managers will employ the services of external fundraising
teams known as placement agents in order to raise capital for their vehicles. The use of
placement agents has grown over the past few years, with 40% of funds closed in 2006
employing their services, according to Preqin ltd (formerly known as Private Equity
Intelligence). Placement agents will approach potential investors on behalf of the fund
manager, and will typically take a fee of around 1% of the commitments that they are
able to garner.

The amount of time that a private equity firm spends raising capital varies depending on
the level of interest among investors, which is defined by current market conditions and
also the track record of previous funds raised by the firm in question. Firms can spend as
little as one or two months raising capital when they are able to reach the target that they
set for their funds relatively easily, often through gaining commitments from existing
investors in their previous funds, or where strong past performance leads to strong levels
of investor interest. Other managers may find fundraising taking considerably longer,
with managers of less popular fund types (such as European venture fund managers in the
current climate) finding the fundraising process more tough. It is not unheard of for funds
to spend as long as two years on the road seeking capital, although the majority of fund
managers will complete fundraising within nine months to fifteen months.

Once a fund has reached its fundraising target, it will have a final close. After this point it
is not normally possible for new investors to invest in the fund, unless they were to
purchase an interest in the fund on the secondary market.

[edit] Size of the industry - Investment activity

Over $90bn of private equity was invested globally in 2009, a significant fall from the
$181bn invested in the previous year. The 2009 total was more than 70% down on record
levels seen in 2007. Deal making however gathered momentum during the year with
larger deals announced towards the end of 2009. With bank lending in short supply, the
average cost of debt financing was up and private equity firms were forced to contribute a
bigger proportion of equity into their deals.

Indicators for the first half of 2010 show that investment activity totalled $55bn with
private equity firms continuing to focus on investments in small and medium sized
companies. The half-year total was up slightly on the same period in 2009 but well down
on the period between 2005 and 2008. Full year figures for 2010 may show a moderate
increase on 2009 if the gradual recovery in investments seen in recent months is
sustained. Private-equity backed deals generated 6.3% of global M&A volume in 2009,
the lowest level in more than a decade and down from the all-time high of 21% in 2006.
This grew to 6.9% in the first half of 2010.

Regional breakdown of private equity activity shows that in 2009, North America
accounted for 36% of private equity investments, up from 26% in the previous year while
its share of funds raised remained at around two-thirds of the total. Europe’s share of
investments fell from 44% to 37% during the year. Its share of funds also declined, from
25% to 15%. While investments have fallen in most regions in recent years, there has
been a rise in the importance of Asia-Pacific and emerging markets, particularly China,
Singapore, South Korea and India. This is partly due to the smaller impact of the
economic crisis on this region and better prospects for economic growth. [66]
[edit] Size of the industry - Fundraising activity

Private equity funds under management totalled $2.5 trillion at the end of 2009 (Chart 3).
Funds available for investments totalled 40% of overall assets under management or
some $1 trillion, a result of high fund raising volumes between 2006 and 2008.[67]

Funds raised fell by two-thirds in 2009 to $150bn, the lowest annual amount raised since
2004. The difficult fund raising conditions have continued into 2010 with half yearly
figures showing a total of $70bn raised in the first six months, slightly below the same
period in 2009. The average time taken for funds to achieve a final close more than
doubled between 2004 and 2010 to almost 20 months and in some cases the final
amounts raised were below original targets. Prior to the economic slowdown, the market
saw intense competition for private equity financing. The three years up to 2009 saw an
unprecedented amount of activity during which more than $1.4 trillion in funds were
raised.

[edit] Private equity fund performance

In the past the performance of private equity funds has been relatively difficult to track,
as private equity firms are under no obligation to publicly reveal the returns that they
have achieved from their investments. In the majority of cases the only groups with
knowledge of fund performance were investors in the funds, academic institutes (as
CEPRES Center of Private Equity Research) and the firms themselves, making
comparisons between various different firms, and the establishment of market
benchmarks to be a difficult challenge.

The application of the Freedom of Information Act (FOIA) in certain states in the United
States has made certain performance data more readily available. Specifically, FOIA has
required certain public agencies to disclose private equity performance data directly on
the their websites[68]. In the United Kingdom, the second largest market for private equity,
more data has become available since the 2007 publication of the David Walker
Guidelines for Disclosure and Transparency in Private Equity[69].

The performance of the private equity industry over the past few years differs between
funds of different types. Buyout and real estate funds have both performed strongly in the
past few years (i.e., from 2003-2007) in comparison with other asset classes such as
public equities. In contrast other fund investment types, venture capital most notably,
have not shown similarly robust performance.

Within each investment type, manager selection (i.e., identifying private equity firms
capable of generating above average performance) is a key determinant of an individual
investor's performance. Historically, performance of the top and bottom quartile
managers has varied dramatically and institutional investors conduct extensive due
diligence in order to assess prospective performance of a new private equity fund.
It is challenging to compare private equity performance to public equity performance, in
particular because private equity fund investments are drawn and returned over time as
investments are made and subsequently realized. One method, first published in 1994, is
the Long and Nickels Index Comparison Method (ICM). Another method which is
gaining ground in academia is the public market equivalent or profitability index. The
profitability index determines the investment in public market investments required to
earn a target profit from a portfolio of private equity fund investments.[70] Driessen, et al.
have recently pushlished a paper, A New Method to Estimate Risk and Return of Non-
Traded Assets from Cash Flows: The Case of Private Equity Funds, on using Generalized
Method of Moments estimators to simultaneously solve for alpha and beta. The
methodology relies on asymptotics, but it does allow the calculation of risk adjusted
returns, which have previously been unavailable or unreliable.

The history of private equity and venture capital and the development of these asset
classes has occurred through a series of boom and bust cycles since the middle of the
20th century. Within the broader private equity industry, two distinct sub-industries,
leveraged buyouts and venture capital experienced growth along parallel, although
interrelated tracks.

Since the origins of the modern private equity industry in 1946, there have been four
major epochs marked by three boom and bust cycles. The early history of private
equity—from 1946 through 1981—was characterized by relatively small volumes of
private equity investment, rudimentary firm organizations and limited awareness of and
familiarity with the private equity industry. The first boom and bust cycle, from 1982
through 1993, was characterized by the dramatic surge in leveraged buyout activity
financed by junk bonds and culminating in the massive buyout of RJR Nabisco before the
near collapse of the leveraged buyout industry in the late 1980s and early 1990s. The
second boom and bust cycle (from 1992 through 2002) emerged out of the ashes of the
savings and loan crisis, the insider trading scandals, the real estate market collapse and
the recession of the early 1990s. This period saw the emergence of more institutionalized
private equity firms, ultimately culminating in the massive Dot-com bubble in 1999 and
2000. The third boom and bust cycle (from 2003 through 2007) came in the wake of
the collapse of the Dot-com bubble—leveraged buyouts reach unparalleled size and the
institutionalization of private equity firms is exemplified by the Blackstone Group's 2007
initial public offering.

In its early years through roughly the year 2000, the history of the private equity and
venture capital asset classes is best described through a narrative of developments in the
United States as private equity in Europe consistently lagged behind the North American
industry. With the second private equity boom in the mid-1990s and liberalization of
regulation for institutional investors in Europe, the emergence of a mature European
private equity market has occurred

Origins of modern private equity

Main article: Early history of private equity
It was not until after World War II that what is considered today to be true private equity
investments began to emerge marked by the founding of the first two venture capital
firms in 1946: American Research and Development Corporation. (ARDC) and J.H.
Whitney & Company.[1]

ARDC was founded by Georges Doriot, the "father of venture capitalism"[2] (founder of
INSEAD and former dean of Harvard Business School), with Ralph Flanders and Karl
Compton (former president of MIT), to encourage private sector investments in
businesses run by soldiers who were returning from World War II. ARDC's significance
was primarily that it was the first institutional private equity investment firm that raised
capital from sources other than wealthy families although it had several notable
investment successes as well.[3] ARDC is credited with the first major venture capital
success story when its 1957 investment of $70,000 in Digital Equipment Corporation
(DEC) would be valued at over $355 million after the company's initial public offering in
1968 (representing a return of over 500 times on its investment and an annualized rate of
return of 101%).[4] Former employees of ARDC went on to found several prominent
venture capital firms including Greylock Partners (founded in 1965 by Charlie Waite and
Bill Elfers) and Morgan, Holland Ventures, the predecessor of Flagship Ventures
(founded in 1982 by James Morgan).[5] ARDC continued investing until 1971 with the
retirement of Doriot. In 1972, Doriot merged ARDC with Textron after having invested
in over 150 companies.

J.H. Whitney & Company was founded by John Hay Whitney and his partner Benno
Schmidt. Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933
and acquiring a 15% interest in Technicolor Corporation with his cousin Cornelius
Vanderbilt Whitney. By far, Whitney's most famous investment was in Florida Foods
Corporation. The company, having developed an innovative method for delivering
nutrition to American soldiers, later came to be known as Minute Maid orange juice and
was sold to The Coca-Cola Company in 1960. J.H. Whitney & Company continues to
make investments in leveraged buyout transactions and raised $750 million for its sixth
institutional private equity fund in 2005.

Before World War II, venture capital investments (originally known as "development
capital") were primarily the domain of wealthy individuals and families. One of the first
steps toward a professionally-managed venture capital industry was the passage of the
Small Business Investment Act of 1958. The 1958 Act officially allowed the U.S. Small
Business Administration (SBA) to license private "Small Business Investment
Companies" (SBICs) to help the financing and management of the small entrepreneurial
businesses in the United States. Passage of the Act addressed concerns raised in a Federal
Reserve Board report to Congress that concluded that a major gap existed in the capital
markets for long-term funding for growth-oriented small businesses. Additionally, it was
thought that fostering entrepreneurial companies would spur technological advances to
compete against the Soviet Union. Facilitating the flow of capital through the economy
up to the pioneering small concerns in order to stimulate the U.S. economy was and still
is the main goal of the SBIC program today.[6] The 1958 Act provided venture capital
firms structured either as SBICs or Minority Enterprise Small Business Investment
Companies (MESBICs) access to federal funds which could be leveraged at a ratio of up
to 4:1 against privately raised investment funds. The success of the Small Business
Administration's efforts are viewed primarily in terms of the pool of professional private
equity investors that the program developed as the rigid regulatory limitations imposed
by the program minimized the role of SBICs. In 2005, the SBA significantly reduced its
SBIC program, though SBICs continue to make private equity investments.

What Does Private Equity Mean?

Equity capital that is not quoted on a public exchange. Private equity consists of investors and
funds that make investments directly into private companies or conduct buyouts of public
companies that result in a delisting of public equity. Capital for private equity is raised from retail
and institutional investors, and can be used to fund new technologies, expand working capital
within an owned company, make acquisitions, or to strengthen a balance sheet.

The majority of private equity consists of institutional investors and accredited investors who can
commit large sums of money for long periods of time. Private equity investments often demand
long holding periods to allow for a turnaround of a distressed company or a liquidity event such as
an IPO or sale to a public company.

Investopedia explains Private Equity

The size of the private equity market has grown steadily since the 1970s. Private equity firms will
sometimes pool funds together to take very large public companies private. Many private equity
firms conduct what are known as leveraged buyouts (LBOs), where large amounts of debt are
issued to fund a large purchase. Private equity firms will then try to improve the financial results
and prospects of the company in the hope of reselling the company to another firm or cashing out
via an IPO.

Private equity refers to a type of investment aimed at gaining significant, or even complete, control of a

company in the hopes of earning a high return. As the name implies, private equity funds invest in assets

that either are not owned publicly or that are publicly owned but the private equity buyer plans to take

private. Though the money used to fund these investments comes from private markets, private equity firms

invest in both privately and publicly held companies. The private equity industry has evolved substantially
over the past decade or so. The basic principle has remained constant: a group of investors buy out a

company and use that company's earnings to pay themselves back. What has changed are the sheer

numbers of recent private equity deals. In the past ten years, the record for the most expensive buyout has

been broken and re-broken several times. Private equity firms have been acquiring companies left and right,

paying sometimes shockingly high premiums over these companies' market values. As a result, takeover

targets are demanding exorbitant prices for their outstanding shares; with the massive buyouts that have

made headlines around the world, companies now expect a certain premium over their current value. One

example is Free-scale Semiconductor, who turned down a deal that paid a nearly 30% premium over its

market value, holding out for a sweeter package, which it received. The sheer number of these high-priced

deals that have occurred in recent years have led some to question whether this pace is sustainable in the

long run. This could turn out to be a self-fulfilling prophecy; as concerns grow and people become less eager
to invest in private equity deals, firms won't be able to raise the money to fund their acquisitions, essentially

crippling the industry.

Who Is Impacted by Private Equity?

Commercial banks

 Bank of America (BAC), Citigroup (C), and J P Morgan Chase (JPM) are among the largest lenders

to private equity firms. These are the main firms who have been stuck with the high-yield bonds that

investors are increasingly reluctant to buy. A decline in private equity would lead to big losses for these

lenders, since they're already sitting on over $40 billion in unsellable debt.[1]

Investment banks

 Goldman Sachs Group (GS), Merrill Lynch (MER), Morgan Stanley (MS), Lehman Brothers Fin SA

(LEH), and other investment banks have been offering billions of dollars in bridge loans, which can be

used to cover the costs of a private equity acquisition until permanent funding is found. These loans

haven't been used that often in the past, but as private equity firms find it harder to raise capital by other

methods, they could start drawing upon these loans, leaving investment banks with billions of dollars of

loans. With the current state of the debt market, these banks could have trouble finding secondary

buyers, meaning that they'd be stuck with heaps of unwanted loans. Also, investment banks are heavily

involved with the underwriting of debt and securities for acquisitions and IPOs. These services bring in

hefty fees for I-banks, and any decrease in demand for private equity-related services would negatively

impact revenues.

Last men standing

As the number of private equity deals has increased, the targets of acquisitions have primarily been small- to

mid-size companies. While larger companies are technically fair game, some are just much too large to be

seriously considered as possible acquisitions. Due to their size, large corporations such as these have

benefited from the privatization in their respective industries. As smaller companies are taken private,

investors wanting exposure to the industry are left with fewer options in terms of stocks; the remaining

companies are seeing higher demand (and higher prices) for their stocks.

 Exxon Mobil (XOM), Royal Dutch Shell (RDS), and ChevronTexaco (CVX) are potential

beneficiaries of private equity deals involving small- to mid-sized oil refineries.

 Piedmont Natural Gas Company (PNY), Northeast Utilities (NU), and Sempra Energy (SRE) may

benefit from a host of global private equity transactions in natural gas.

 PriPrivate Equity Goes Public

 Blackstone Group (BX) is one of the first private equity firms that has gone public with a recent

initial public offering in June 2007. China took a $3 billion stake before the IPO, which amounts to

approximately 10% of the company's value. Blackstone manages about $800 billion in capital, ranking it

as one of the top private equity firms by assets. Most market observers remain optimistic that

Blackstone will deliver strong value to shareholders over time, given their excellent investment record

since the company's inception.

 KKR--a leading private equity firm originally known as Kohlberg, Kravis, Roberts--announced in

early July, 2007, that it was planning to go public. KKR is famous for its involvement in high-profile

buyouts, including the $45 billion buyout of TXU in February 2007. According to their filings with the

SEC, the company said it would sell up to $1.3 billion in common equity units and use proceeds to

expand the business. It was reported later that same month that poor conditions in the debt market

could delay KKR's IPO, as the firm is finding it more difficult to arrange financing for its deals.

What is private equity?

Private equity is essentially a way to invest in some asset that isn't publicly traded, or to invest in a publicly

traded asset with the intention of taking it private. Unlike stocks, mutual funds, and bonds, private equity

funds usually invest in more illiquid assets, i.e. companies. By purchasing companies, the firms gain access

to those companies' assets and revenue sources, which can lead to very high returns on investments.

Another feature of these private equity transactions is their extensive use of debt in the form of high-yield

bonds. By using debt to finance acquisitions, private equity firms can substantially increase their financial
returns. The debt used in buyouts has a relatively fixed cost, so if a private equity fund's return on assets

(ROA) is greater than this cost, the fund's return on equity (ROE) is higher than if it hadn't borrowed money.

The same principle applies in reverse, however, making these leveraged buyouts potentially very risky; if the

acquired company's ROA is lower than the cost of the debt used to buy it, then the private equity fund's ROE

is less than if hadn't used debt. The firm would lose money on the investment and still have to pay back the

loans, a situation similar to having negative equity in the housing market.

While private equity firms sometimes pay themselves back using the acquired company's profits, this isn't

their principal moneymaking area. Actually, clauses in private equity deals known as covenants, which

assure such repayment, have become increasingly rare in recent years. Rather than making money from

guaranteed minimum dividends, etc., private equity firms have been generating most of their profit from the

"exit event", or the time when they either sell the company to another private entity or return it to the public

markets, presumably for a higher price than they paid originally. Especially with their heavy use of leverage

to acquire companies, private equity firms can make a substantial profit in this way. One example is the

acquisition of Hertz Global Holdings (HTZ), the car rental company. When Ford Motor Company (F) decided

to sell the company in 2005, private equity firms Clayton, Dubilier, and Rice, Inc., Carlyle Group, and Merrill

Lynch Global Private Equity stepped in to buy the company. When the deal was completed in December of

2005, the firms had put up $2.3 billion in equity, and the acquired Hertz had taken on $12.5 billion in debt.

Just eleven months later, Hertz was returned to the public markets with an IPO; even before the exit, Hertz

paid $991 million to the firms in special dividends, $25 million to each for "acquisition services", and $2.25

million in other various fees. After the IPO, the three firms received another round of special dividends

valued at around $427 million and $15 million to terminate standing agreements. Now, the three firms hold a

combined 91.9 million shares of Hertz, valued at almost $2.1 billion (up 43% since the IPO in November of

2006). Merrill Lynch made out particularly well; in addition to its private equity firm doubling its investment in

a year, the firm itself collected advisory fees for both the acquisition and the IPO and now holds 75 million

shares of Hertz in addition to its private equity division's 32 million.

What drives private equity?

Raising Capital

Why would a company agree to sell a part of its interests to a private equity firm? There may be several

reasons. First, the company may need a large inflow of capital for long-term productivity investments such

as research and development. Rather than waiting several quarters (or years) to gather sufficient capital, the

company may choose to sell part of its interests in exchange for the ability to pursue development projects

sooner. This may be especially true of highly time-sensitive industries such as technology (e.g. software,
telecommunications, and Internet services), where a few quarters may make a critical difference in a

company’s ability to gain (or maintain) a market advantage.

Increasing Regulation of Public Markets

Second, given the increasing regulation and scrutiny in the public markets over the last several years, some

companies may wish to avoid having their destinies controlled—or at least heavily influenced—by public

shareholders. In a public company, shareholders have the right to cast votes with regard to any number of

issues critical to the company. In a private equity transaction, such rights typically do not exist. Accordingly,

a company can raise capital without relinquishing operating control to external shareholders. Nevertheless, a

private equity firm does retain some control, such as the ability to influence the composition of management

teams. Often, a private equity firm may take an interest in a company on the condition that the company

install new management—which ideally will improve operating results and drive profits.

Effect on Public Markets

For stock market investors, the real question is how the private equity market has affected public markets

and what its likely effects will be in the future. Many analysts argue that the increase in private equity deals

has actually benefited some aspects of the stock market; the reason is that, with so many companies going

private, it’s become harder for public investors to gain exposure to industries where private equity has been

especially influential. Small- to mid-size firms in the energy and finance industries are prime examples. With

the increase in private equity deals, the availability of publicly traded shares of such companies has

decreased. This decrease in supply has caused the remaining shares to increase in price; as there are

fewer available, each becomes more valuable.

Also, private equity can boost a company's stock price if people think a buyout is likely. Companies that are

perceived as likely targets of private equity buyouts have seen their stock prices rise in anticipation of the
transaction. Given recent trends in the private equity industry, investors often feel safe in assuming that

private equity firms will pay a hefty premium over a company's market value. This drove up the stock prices

for companies such as Martha Stewart Living Omnimedia (MSO) and Radioshack (RSH), which were

commonly mentioned as buyout targets.

Financing the Private Equity Boom

One beneficiary of private equity's strength is certain: the financial firms who structure the deals. Whether

they're lenders or underwriters (such as investment banks), a number of financial firms have used their

market savvy and extensive industry contacts to ensure that they're in the middle of what has been one of

the most profitable trends over the past market cycle. That said, if long-term interest rates continue to rise

over the next one to two years, it could become more difficult for financial firms to find the capital and

participants necessary to keep private equity deals moving at the same rapid pace.

Has private equity reached its peak?

The subprime-inspired housing slump and its subsequent impact on Wall Street investment banks have

somewhat diminished investors' appetite for risk. While the potential returns from a private equity firm's

leveraged buyout of a company can be great, investors have begun to realize just how risky the highly

leveraged transactions can be. This has been making it increasingly difficult for private equity firms and the

investment banks that structure their deals to find people willing to invest in their risky, high-yield bonds.

A number of recent debt offerings, including the debt used in Cerberus Capital Management's buyout of the

Chrysler Group, have been postponed or abandoned due to deteriorating conditions in the U.S. debt market.

On July 25, 2007, it was announced that Deutsche Bank AG (DB), J P Morgan Chase (JPM), and six other

banks were stuck with around $10 billion of loans that they couldn't sell; the debt was used for private equity

firm KKR's acquisition of Alliance Boots Plc. [2] This increasingly common occurrence is hitting banks hard;

they can either cut their losses and sell the loans on the cheap or wait until conditions improve, neither of

which is particularly appealing.

As the debt market contracts, companies that were previously touted as LBO targets, including Martha

Stewart Living Omnimedia (MSO) and Radioshack (RSH), are seeing their stock prices plummet. The same

logic that drove their stocks higher and higher also led to their fall; when investors heard the speculation

about a slowdown in private equity, they realized that they might not be able to sell their shares at the

premium price they'd been hoping for. Shareholders scrambled to sell their stock while the price was still

relatively overinflated. Martha Stewart and Radioshack stocks plunged 25% and 30%, respectively, in just

three weeks.[3]
vate Equity Goes Public

Private equity fund is a collective investment scheme used for making investments in
various equity (and to a lesser extent debt) securities according to one of the investment
strategies associated with private equity. Private equity funds are typically limited
partnerships with a fixed term of 10 years (often with annual extensions). At inception,
institutional investors make an unfunded commitment to the limited partnership, which is
then drawn over the term of the fund.

A private equity fund is raised and managed by investment professionals of a specific

private equity firm (the general partner and investment advisor). Typically, a single
private equity firm will manage a series of distinct private equity funds and will attempt
to raise a new fund every 3 to 5 years as the previous fund is fully invested.

Legal Structure and Terms

Diagram of the structure of a generic private equity fund

Most private equity funds are structured as limited partnerships and are governed by the
terms set forth in the limited partnership agreement or LPA. Such funds have a general
partner (GP), which raises capital from cash-rich institutional investors, such as pension
plans, universities, insurance companies, foundations, endowments, and high net worth
individuals, which invest as limited partners (LPs) in the fund. Among the terms set forth
in the limited partnership agreement are the following:

• Term of the partnership — the partnership is usually a fixed-life investment

vehicle that is typically 10 years plus some number of extensions.

• Management fees — an annual payment made by the investors in the fund to the
fund's manager to pay for the private equity firm's investment operations
(typically 1 to 2% of the committed capital of the fund.[1]

• Carried interest — a share of the profits of the fund's investments (typically up to

20%), paid to the private equity fund’s management company as a performance
incentive. The remaining 80% of the profits are paid to the fund's investors.[1]

• Hurdle Rate or preferred return — a minimum rate of return (e.g. 8–12%), which
must be achieved before the fund manager can receive any carried interest
payments.

• Transfer of an interest in the fund — private equity funds are not intended to be
transferred or traded; however, they can be transferred to another investor.
Typically, such a transfer must receive the consent of and is at the discretion of
the fund's manager.
 • Restrictions on the General Partner — the fund's manager has significant
discretion to make investments and control the affairs of the fund. However, the
LPA does have certain restrictions and controls and is often limited in the type,
size, or geographic focus of investments permitted, and how long the manager is
permitted to make new investments.

[edit] Private Equity Investments and Financing

A private equity fund typically makes investments in companies (known as portfolio
companies). These portfolio company investments are funded with the capital raised from
LPs, and may be partially or substantially financed by debt. Some private equity
investment transactions can be highly leveraged with debt financing—hence the acronym
LBO for "leveraged buy-out". The cash flow from the portfolio company usually
provides the source for the repayment of such debt.

Such LBO financing most often comes from commercial banks, although other financial
institutions, such as hedge funds and mezzanine funds, may also provide financing. Since
mid-2007, debt financing has become much more difficult to obtain for private equity
funds than in previous years.

LBO funds commonly acquire most of the equity interests or assets of the portfolio
company through a newly-created special purpose acquisition subsidiary controlled by
the fund, and sometimes as a consortium of several like-minded funds.

[edit] Private Equity Multiples and Prices

The acquisition price of a portfolio company is usually based on a multiple of the
company’s historical income, most often based on the measure of earnings before interest
taxes depreciation and amortization (EBITDA). Private equity multiples are highly
dependent on the portfolio company's industry, the size of the company, and the
availability of LBO financing.

[edit] Portfolio Company Sales (or "Exits")

A private equity fund's ultimate goal is to sell or "exit" its investments in portfolio
companies for a return, known as internal rate of return or "IRR", in excess of the price
paid. These exit scenarios historically have been an IPO of the portfolio company or a
sale of the company to a strategic acquirer through a merger or acquisition (M&A), also
known as a trade sale. Increasingly, more common has been a sale of the portfolio
company to another private equity firm, also known as a "secondary sale". In prior years,
another exit strategy has been a preferred dividend by the portfolio company to the
private equity fund to repay the capital investment, sometimes financed with additional
debt.
[edit] Private equity funds and private equity firms: an
illustration
The following is an illustration of the difference between a private equity fund and a
private equity firm:

Private Equity Firm Private Equity Fund Private Equity Portfolio

Investments (Partial List)
Kohlberg Kravis Roberts & KKR 2006 Fund, L.P. Alliance Boots
Co. (KKR) ($17.6 billion of
commitments)
Dollar General
Energy Future Holdings
Corporation
First Data Corp
Hospital Corporation of
America (HCA)
Nielsen Company
NXP Semiconductors

[edit] Investment features and considerations

Considerations for investing in private equity funds relative to other forms of investment
include:

• Substantial entry requirements — with most private equity funds requiring

significant initial commitment (usually upwards of $1,000,000), which can be
drawn at the manager's discretion over the first few years of the fund.

• Limited liquidity — investments in limited partnership interests (which is the

dominant legal form of private equity investments) are referred to as "illiquid"
investments, which should earn a premium over traditional securities, such as
stocks and bonds. Once invested, it is very difficult to achieve liquidity before the
manager realizes the investments in the portfolio as an investor's capital is locked-
up in long-term investments, which can last for as long as twelve years.
Distributions are made only as investments are converted to cash; limited partners
typically have no right to demand that sales be made.

• Investment Control — nearly all investors in private equity are passive and rely
on the manager to make investments and generate liquidity from those
investments. Typically, governance rights for limited partners in private equity
funds are minimal.
 • Unfunded Commitments — an investor's commitment to a private equity fund is
drawn over time. If a private equity firm cannot find suitable investment
opportunities, it will not draw on an investor's commitment, and an investor may
potentially invest less than expected or committed.

• Investment Risks — given the risks associated with private equity investments, an
investor can lose all of its investment. The risk of loss of capital is typically
higher in venture capital funds, which invest in companies during the earliest
phases of their development or in companies with high amounts of financial
leverage. By their nature, investments in privately held companies tend to be
riskier than investments in publicly traded companies.

• High returns — consistent with the risks outlined above, private equity can
provide high returns, with the best private equity managers significantly
outperforming the public markets.[2]

For the above mentioned reasons, private equity fund investment is for those who can
afford to have capital locked in for long periods of time and who are able to risk losing
significant amounts of money. These disadvantages are offset by the potential benefits of
annual returns, which range up to 30% for successful funds.

To understand what a private equity firm is, it is important to understand what the different parts of the term
mean. Equity is the value of an asset less any associated liability. Private equity is the equity in an asset that isn't
freely tradeable on the public stock market. A private equity firm, then, is the controlling partner in a collection
of partnerships that have come together to pool their capital and invest in a particular opportunity.

While private equity firms may focus on a variety of investment strategies, including drumming up venture
capital, they often buy undervalued or under-appreciated companies, improve them, and then sell them for a
profit, sort of like house flipping but in a commercial setting. After buying a company, a private equity firm will
remove it from the stock market. This allows the firm to make tough or controversial decisions without having to
answer to or release sensitive information to shareholders or the public generally. By making the company
private, the private equity firm is basically only accountable to its smaller group of investors.

In order to turn the company around, a private equity firm will often replace or control the management team of
the company. It isn't unusual, however, for the equity firm to keep existing employees of an existing company.
While the equity firm is controlling the company, it's goal is usually to determine how it can improve the
company's performance or projected future performance so that potential investors will buy the company at a
profit.

Private equity funding can come from a variety of sources. Most often, the funds come from pension funds,
financial institutions, or individual investors with a substantial net worth. By being able to pool such large
amounts of investment capital, the private equity firm expands its reach to, and power over, potential investment
opportunities.

Venture capital
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 Financial market
participants

• Collective investment
schemes
• Credit unions
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• Pension funds
• Prime Brokers

• Trusts
Finance series

• Financial market
• Participants
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• Financial regulation
v•d•e

History of private equity

and venture capital

Early history
(Origins of modern private equity)
 •
The 1980s
(LBO boom)
•
The 1990s
(LBO bust and the VC bubble)
•
The 2000s
(Dot-com bubble to the credit crunch)
v•d•e

Venture capital (also known as VC or Venture) is provided as seed funding to early-

stage, high-potential, growth companies and more often after the seed funding round as
growth funding round (also referred as series A round) in the interest of generating a
return through an eventual realization event such as an IPO or trade sale of the company.
To put it simply, an investment firm will give money to a growing company. The
growing company will then use this money to advertise, do research, build infrastructure,
develop products etc. The investment firm is called a venture capital firm, and the money
that it gives is called venture capital. The venture capital firm makes money by owning a
stake in the firm it invests in. The firms that a venture capital firm will invest in usually
have a novel technology or business model. Venture capital investments are generally
made in cash in exchange for shares in the invested company. It is typical for venture
capital investors to identify and back companies in high technology industries, such as
biotechnology and IT (Information Technology).

Venture capital typically comes from institutional investors and high net worth
individuals, and is pooled together by dedicated investment firms.

Venture capital firms typically comprise small teams with technology backgrounds
(scientists, researchers) or those with business training or deep industry experience.

A core skill within VC is the ability to identify novel technologies that have the potential
to generate high commercial returns at an early stage. By definition, VCs also take a role
in managing entrepreneurial companies at an early stage, thus adding skills as well as
capital (thereby differentiating VC from buy-out private equity, which typically invest in
companies with proven revenue), and thereby potentially realizing much higher rates of
returns. Inherent in realizing abnormally high rates of returns is the risk of losing all of
one's investment in a given startup company. As a consequence, most venture capital
investments are done in a pool format, where several investors combine their investments
into one large fund that invests in many different startup companies. By investing in the
pool format, the investors are spreading out their risk to many different investments
versus taking the chance of putting all of their money in one start up firm.

A venture capitalist (also known as a VC) is a person or investment firm that makes
venture investments, and these venture capitalists are expected to bring managerial and
technical expertise as well as capital to their investments. A venture capital fund refers
to a pooled investment vehicle (often an LP or LLC) that primarily invests the financial
capital of third-party investors in enterprises that are too risky for the standard capital
markets or bank loans.

Venture capital is also associated with job creation, the knowledge economy, and used as
a proxy measure of innovation within an economic sector or geography.

In addition to angel investing and other seed funding options, venture capital is attractive
for new companies with limited operating history that are too small to raise capital in the
public markets and have not reached the point where they are able to secure a bank loan
or complete a debt offering. In exchange for the high risk that venture capitalists assume
by investing in smaller and less mature companies, venture capitalists usually get
significant control over company decisions, in addition to a significant portion of the
company's ownership (and consequently value).

Young companies wishing to raise venture capital require a combination of extremely

rare, yet sought after, qualities, such as innovative technology, potential for rapid growth,
a well-developed business model, and an impressive management team. VCs typically
reject 98% of opportunities presented to them[citation needed], reflecting the rarity of this
combination.

Contents
[hide]

• 1 Background
o 1.1 Origins of modern private equity
• 2 Early venture capital and the growth of Silicon Valley
o 2.1 Venture capital in the 1980s
o 2.2 The venture capital boom and the Internet Bubble (1995 to 2000)
o 2.3 The bursting of the Internet Bubble and the private equity crash (2000
to 2003)
• 3 Venture capital firms and funds
o 3.1 Structure of Venture Capital Firms
o 3.2 Types of Venture Capital Firms
o 3.3 Roles within Venture Capital Firms
o 3.4 Structure of the funds
o 3.5 Compensation
• 4 Venture capital funding
o 4.1 Main alternatives to venture capital
• 5 Geographical differences
o 5.1 United States
o 5.2 Canada
o 5.3 Europe
o 5.4 China
• 6 Confidential information
 • 7 Popular culture
• 8 See also
• 9 Notes
• 10 References

• 11 External links

[edit] Background
Main article: History of private equity and venture capital

With few exceptions, private equity in the first half of the 20th century was the domain of
wealthy individuals and families. The Vanderbilts, Whitneys, Rockefellers, and
Warburgs were notable investors in private companies in the first half of the century. In
1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines and
Douglas Aircraft and the Rockefeller family had vast holdings in a variety of companies.
Eric M. Warburg founded E.M. Warburg & Co. in 1938, which would ultimately become
Warburg Pincus, with investments in both leveraged buyouts and venture capital.

[edit] Origins of modern private equity

Before World War II, money orders (originally known as "development capital") were
primarily the domain of wealthy individuals and families. It was not until after World
War II that what is considered today to be true private equity investments began to
emerge marked by the founding of the first two venture capital firms in 1946: American
Research and Development Corporation. (ARDC) and J.H. Whitney & Company.[1]

ARDC was founded by Georges Doriot, the "father of venture capitalism"[2] (former dean
of Harvard Business School and founder of INSEAD), with Ralph Flanders and Karl
Compton (former president of MIT), to encourage private sector investments in
businesses run by soldiers who were returning from World War II. ARDC's significance
was primarily that it was the first institutional private equity investment firm that raised
capital from sources other than wealthy families although it had several notable
investment successes as well.[3] ARDC is credited with the first trick when its 1957
investment of $70,000 in Digital Equipment Corporation (DEC) would be valued at over
$355 million after the company's initial public offering in 1968 (representing a return of
over 1200 times on its investment and an annualized rate of return of 101%).[4] Former
employees of ARDC went on and established several prominent venture capital firms
including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and
Morgan, Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by
James Morgan).[5] ARDC continued investing until 1971 with the retirement of Doriot. In
1972, Doriot merged ARDC with Textron after having invested in over 150 companies.

J.H. Whitney & Company was founded by John Hay Whitney and his partner Benno
Schmidt. Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933
and acquiring a 15% interest in Technicolor Corporation with his cousin Cornelius
Vanderbilt Whitney. By far Whitney's most famous investment was in Florida Foods
Corporation. The company developed an innovative method for delivering nutrition to
American soldiers, which later came to be known as Minute Maid orange juice and was
sold to The Coca-Cola Company in 1960. J.H. Whitney & Company continues to make
investments in leveraged buyout transactions and raised $750 million for its sixth
institutional private equity fund in 2005.

[edit] Early venture capital and the growth of Silicon

Valley

Sand Hill Road in Menlo Park, California, where many Bay Area venture capital firms
are based

One of the first steps toward a professionally-managed venture capital industry was the
passage of the Small Business Investment Act of 1958. The 1958 Act officially allowed
the U.S. Small Business Administration (SBA) to license private "Small Business
Investment Companies" (SBICs) to help the financing and management of the small
entrepreneurial businesses in the United States.[6]

During the 1960s and 1970s, venture capital firms focused their investment activity
primarily on starting and expanding companies. More often than not, these companies
were exploiting breakthroughs in electronic, medical, or data-processing technology. As a
result, venture capital came to be almost synonymous with technology finance.

An early West Coast venture capital company was Draper and Johnson Investment
Company, formed in 1962[7] by William Henry Draper III and Franklin P. Johnson, Jr. In
1964 Bill Draper and Paul Wythes founded Sutter Hill Ventures, and Pitch Johnson
formed Asset Management Company.
It is commonly noted that the first venture-backed startup is Fairchild Semiconductor
(which produced the first commercially practical integrated circuit), funded in 1959 by
what would later become Venrock Associates.[8] Venrock was founded in 1969 by
Laurance S. Rockefeller, the fourth of John D. Rockefeller's six children as a way to
allow other Rockefeller children to develop exposure to venture capital investments.

It was also in the 1960s that the common form of private equity fund, still in use today,
emerged. Private equity firms organized limited partnerships to hold investments in
which the investment professionals served as general partner and the investors, who were
passive limited partners, put up the capital. The compensation structure, still in use today,
also emerged with limited partners paying an annual management fee of 1-2% and a
carried interest typically representing up to 20% of the profits of the partnership.

The growth of the venture capital industry was fueled by the emergence of the
independent investment firms on Sand Hill Road, beginning with Kleiner, Perkins,
Caufield & Byers and Sequoia Capital in 1972. Located, in Menlo Park, CA, Kleiner
Perkins, Sequoia and later venture capital firms would have access to the burgeoning
technology industries in the area. By the early 1970s, there were many semiconductor
companies based in the Santa Clara Valley as well as early computer firms using their
devices and programming and service companies.[9] Throughout the 1970s, a group of
private equity firms, focused primarily on venture capital investments, would be founded
that would become the model for later leveraged buyout and venture capital investment
firms. In 1973, with the number of new venture capital firms increasing, leading venture
capitalists formed the National Venture Capital Association (NVCA). The NVCA was to
serve as the industry trade group for the venture capital industry.[10] Venture capital firms
suffered a temporary downturn in 1974, when the stock market crashed and investors
were naturally wary of this new kind of investment fund.

It was not until 1978 that venture capital experienced its first major fundraising year, as
the industry raised approximately $750 million. With the passage of the Employee
Retirement Income Security Act (ERISA) in 1974, corporate pension funds were
prohibited from holding certain risky investments including many investments in
privately held companies. In 1978, the US Labor Department relaxed certain of the
ERISA restrictions, under the "prudent man rule,"[11] thus allowing corporate pension
funds to invest in the asset class and providing a major source of capital available to
venture capitalists.

[edit] Venture capital in the 1980s

The public successes of the venture capital industry in the 1970s and early 1980s (e.g.,
Digital Equipment Corporation, Apple Inc., Genentech) gave rise to a major proliferation
of venture capital investment firms. From just a few dozen firms at the start of the
decade, there were over 650 firms by the end of the 1980s, each searching for the next
major "home run". While the number of firms multiplied, the capital managed by these
firms increased by only 11% from $28 billion to $31 billion over the course of the
decade.[12]
The growth of the industry was hampered by sharply declining returns and certain
venture firms began posting losses for the first time. In addition to the increased
competition among firms, several other factors impacted returns. The market for initial
public offerings cooled in the mid-1980s before collapsing after the stock market crash in
1987 and foreign corporations, particularly from Japan and Korea, flooded early stage
companies with capital.[12]

In response to the changing conditions, corporations that had sponsored in-house venture
investment arms, including General Electric and Paine Webber either sold off or closed
these venture capital units. Additionally, venture capital units within Chemical Bank and
Continental Illinois National Bank, among others, began shifting their focus from funding
early stage companies toward investments in more mature companies. Even industry
founders J.H. Whitney & Company and Warburg Pincus began to transition toward
leveraged buyouts and growth capital investments.[12][13][14]

[edit] The venture capital boom and the Internet Bubble (1995 to 2000)

By the end of the 1980s, venture capital returns were relatively low, particularly in
comparison with their emerging leveraged buyout cousins, due in part to the competition
for hot startups, excess supply of IPOs and the inexperience of many venture capital fund
managers. Growth in the venture capital industry remained limited throughout the 1980s
and the first half of the 1990s increasing from $3 billion in 1983 to just over $4 billion
more than a decade later in 1994.

After a shakeout of venture capital managers, the more successful firms retrenched,
focusing increasingly on improving operations at their portfolio companies rather than
continuously making new investments. Results would begin to turn very attractive,
successful and would ultimately generate the venture capital boom of the 1990s. Former
Wharton Professor Andrew Metrick refers to these first 15 years of the modern venture
capital industry beginning in 1980 as the "pre-boom period" in anticipation of the boom
that would begin in 1995 and last through the bursting of the Internet bubble in 2000.[15]

The late 1990s were a boom time for venture capital, as firms on Sand Hill Road in
Menlo Park and Silicon Valley benefited from a huge surge of interest in the nascent
Internet and other computer technologies. Initial public offerings of stock for technology
and other growth companies were in abundance and venture firms were reaping large
returns.

[edit] The bursting of the Internet Bubble and the private equity crash
(2000 to 2003)

The technology-heavy NASDAQ Composite index peaked at 5,048 in March 2000,

reflecting the high point of the dot-com bubble.
The Nasdaq crash and technology slump that started in March 2000 shook virtually the
entire venture capital industry as valuations for startup technology companies collapsed.
Over the next two years, many venture firms had been forced to write-off large
proportions of their investments and many funds were significantly "under water" (the
values of the fund's investments were below the amount of capital invested). Venture
capital investors sought to reduce size of commitments they had made to venture capital
funds and in numerous instances, investors sought to unload existing commitments for
cents on the dollar in the secondary market. By mid-2003, the venture capital industry
had shriveled to about half its 2001 capacity. Nevertheless, PricewaterhouseCoopers'
MoneyTree Survey shows that total venture capital investments held steady at 2003
levels through the second quarter of 2005.

Although the post-boom years represent just a small fraction of the peak levels of venture
investment reached in 2000, they still represent an increase over the levels of investment
from 1980 through 1995. As a percentage of GDP, venture investment was 0.058%
percent in 1994, peaked at 1.087% (nearly 19 times the 1994 level) in 2000 and ranged
from 0.164% to 0.182 % in 2003 and 2004. The revival of an Internet-driven
environment in 2004 through 2007 helped to revive the venture capital environment.
However, as a percentage of the overall private equity market, venture capital has still not
reached its mid-1990s level, let alone its peak in 2000.

Venture capital funds, which were responsible for much of the fundraising volume in
2000 (the height of the dot-com bubble), raised only $25.1 billion in 2006, a 2% percent
decline from 2005 and a significant decline from its peak.[16]

[edit] Venture capital firms and funds

Diagram of the structure of a generic venture capital fund

Main articles: Private equity firm and Private equity fund

[edit] Structure of Venture Capital Firms

Venture capital firms are typically structured as partnerships, the general partners of
which serve as the managers of the firm and will serve as investment advisors to the
venture capital funds raised. Venture capital firms in the United States may also be
structured as limited liability companies, in which case the firm's managers are known as
managing members. Investors in venture capital funds are known as limited partners.
This constituency comprises both high net worth individuals and institutions with large
amounts of available capital, such as state and private pension funds, university financial
endowments, foundations, insurance companies, and pooled investment vehicles, called
fund of funds or mutual funds.

[edit] Types of Venture Capital Firms

Depending on your business type, the venture capital firm you approach will differ.[17] For
instance, if you're a startup internet company, funding requests from a more
manufacturing-focused firm will not be effective. Doing some initial research on which
firms to approach will save time and effort. When approaching a VC firm, consider their
portfolio:

• Business Cycle: Do they invest in budding or established businesses?

• Industry: What is their industry focus?
• Investment: Is their typical investment sufficient for your needs?
• Location: Are they regional, national or international?
• Return: What is their expected return on investment?
• Involvement: What is their involvement level?

Targeting specific types of firms will yield the best results when seeking VC financing.
Wikipedia has a list of venture capital firms that can help you in your initial exploration.
The National Venture Capital Association segments dozens of VC firms into ways that
might assist you in your search.[18] It is important to note that many VC firms have
diverse portfolios with a range of clients. If this is the case, finding gaps in their portfolio
is one strategy that might succeed.

[edit] Roles within Venture Capital Firms

Within the venture capital industry, the general partners and other investment
professionals of the venture capital firm are often referred to as "venture capitalists" or
"VCs". Typical career backgrounds vary, but broadly speaking venture capitalists come
from either an operational or a finance background. Venture capitalists with an
operational background tend to be former founders or executives of companies similar to
those which the partnership finances or will have served as management consultants.
Venture capitalists with finance backgrounds tend to have investment banking or other
corporate finance experience.

Although the titles are not entirely uniform from firm to firm, other positions at venture
capital firms include:

• Venture partners - Venture partners are expected to source potential investment

opportunities ("bring in deals") and typically are compensated only for those deals
with which they are involved.

• Entrepreneur-in-residence (EIR) - EIRs are experts in a particular domain and

perform due diligence on potential deals. EIRs are engaged by venture capital
firms temporarily (six to 18 months) and are expected to develop and pitch startup
ideas to their host firm (although neither party is bound to work with each other).
Some EIR's move on to executive positions within a portfolio company.

• Principal - This is a mid-level investment professional position, and often

considered a "partner-track" position. Principals will have been promoted from a
 senior associate position or who have commensurate experience in another field
such as investment banking or management consulting.

• Associate - This is typically the most junior apprentice position within a venture
capital firm. After a few successful years, an associate may move up to the
"senior associate" position and potentially principal and beyond. Associates will
often have worked for 1–2 years in another field such as investment banking or
management consulting.

[edit] Structure of the funds

Most venture capital funds have a fixed life of 10 years, with the possibility of a few
years of extensions to allow for private companies still seeking liquidity. The investing
cycle for most funds is generally three to five years, after which the focus is managing
and making follow-on investments in an existing portfolio. This model was pioneered by
successful funds in Silicon Valley through the 1980s to invest in technological trends
broadly but only during their period of ascendance, and to cut exposure to management
and marketing risks of any individual firm or its product.

In such a fund, the investors have a fixed commitment to the fund that is initially
unfunded and subsequently "called down" by the venture capital fund over time as the
fund makes its investments. There are substantial penalties for a Limited Partner (or
investor) that fails to participate in a capital call.

It can take anywhere from a month or so to several years for venture capitalists to raise
money from limited partners for their fund. At the time when all of the money has been
raised, the fund is said to be closed and the 10 year lifetime begins. Some funds have
partial closes when one half (or some other amount) of the fund has been raised. "Vintage
year" generally refers to the year in which the fund was closed and may serve as a means
to stratify VC funds for comparison. This free database of venture capital funds shows
the difference between a venture capital fund management company and the venture
capital funds managed by them.

[edit] Compensation

Main article: Carried interest

Venture capitalists are compensated through a combination of management fees and

carried interest (often referred to as a "two and 20" arrangement):

• Management fees – an annual payment made by the investors in the fund to the
fund's manager to pay for the private equity firm's investment operations.[19] In a
typical venture capital fund, the general partners receive an annual management
fee equal to up to 2% of the committed capital.
 • Carried interest - a share of the profits of the fund (typically 20%), paid to the
private equity fund’s management company as a performance incentive. The
remaining 80% of the profits are paid to the fund's investors[19] Strong Limited
Partner interest in top-tier venture firms has led to a general trend toward terms
more favorable to the venture partnership, and certain groups are able to
command carried interest of 25-30% on their funds.

Because a fund may run out of capital prior to the end of its life, larger venture capital
firms usually have several overlapping funds at the same time; this lets the larger firm
keep specialists in all stages of the development of firms almost constantly engaged.
Smaller firms tend to thrive or fail with their initial industry contacts; by the time the
fund cashes out, an entirely-new generation of technologies and people is ascending,
whom the general partners may not know well, and so it is prudent to reassess and shift
industries or personnel rather than attempt to simply invest more in the industry or people
the partners already know.

[edit] Venture capital funding

Venture capitalists are typically very selective in deciding what to invest in; as a rule of
thumb, a fund may invest in one in four hundred opportunities presented to it. Funds are
most interested in ventures with exceptionally high growth potential, as only such
opportunities are likely capable of providing the financial returns and successful exit
event within the required timeframe (typically 3–7 years) that venture capitalists expect.

Because investments are illiquid and require 3–7 years to harvest, venture capitalists are
expected to carry out detailed due diligence prior to investment. Venture capitalists also
are expected to nurture the companies in which they invest, in order to increase the
likelihood of reaching an IPO stage when valuations are favourable. Venture capitalists
typically assist at four stages in the company's development:[20]

• Idea generation;
• Start-up;
• Ramp up; and
• Exit

There are typically six stages of financing offered in Venture Capital, that roughly
correspond to these stages of a company's development.[21]

• Seed Money: Low level financing needed to prove a new idea (Often provided by
"angel investors")
• Start-up: Early stage firms that need funding for expenses associated with
marketing and product development
• First-Round: Early sales and manufacturing funds
• Second-Round: Working capital for early stage companies that are selling
product, but not yet turning a profit
 • Third-Round: Also called Mezzanine financing, this is expansion money for a
newly profitable company
• Fourth-Round: Also called bridge financing, 4th round is intended to finance the
"going public" process

Because there are no public exchanges listing their securities, private companies meet
venture capital firms and other private equity investors in several ways, including warm
referrals from the investors' trusted sources and other business contacts; investor
conferences and symposia; and summits where companies pitch directly to investor
groups in face-to-face meetings, including a variant know as "Speed Venturing", which is
akin to speed-dating for capital, where the investor decides within 10 minutes whether
s/he wants a follow-up meeting. In addition there are some new private online networks
that are emerging to provide additional opportunities to meet investors. [22]

This need for high returns makes venture funding an expensive capital source for
companies, and most suitable for businesses having large up-front capital requirements
which cannot be financed by cheaper alternatives such as debt. That is most commonly
the case for intangible assets such as software, and other intellectual property, whose
value is unproven. In turn this explains why venture capital is most prevalent in the fast-
growing technology and life sciences or biotechnology fields.

If a company does have the qualities venture capitalists seek including a solid business
plan, a good management team, investment and passion from the founders, a good
potential to exit the investment before the end of their funding cycle, and target minimum
returns in excess of 40% per year, it will find it easier to raise venture capital.

[edit] Main alternatives to venture capital

Because of the strict requirements venture capitalists have for potential investments,
many entrepreneurs seek seed funding from angel investors, who may be more willing to
invest in highly speculative opportunities, or may have a prior relationship with the
entrepreneur.

Furthermore, many venture capital firms will only seriously evaluate an investment in a
start-up company otherwise unknown to them if the company can prove at least some of
its claims about the technology and/or market potential for its product or services. To
achieve this, or even just to avoid the dilutive effects of receiving funding before such
claims are proven, many start-ups seek to self-finance sweat equity until they reach a
point where they can credibly approach outside capital providers such as venture
capitalists or angel investors. This practice is called "bootstrapping".

There has been some debate since the dot com boom that a "funding gap" has developed
between the friends and family investments typically in the $0 to $250,000 range and the
amounts that most Venture Capital Funds prefer to invest between $1 to $2M. This
funding gap may be accentuated by the fact that some successful Venture Capital funds
have been drawn to raise ever-larger funds, requiring them to search for correspondingly
larger investment opportunities. This 'gap' is often filled by sweat equity and seed
funding via angel investors as well as equity investment companies who specialize in
investments in startup companies from the range of $250,000 to $1M. The National
Venture Capital Association estimates that the latter now invest more than $30 billion a
year in the USA in contrast to the $20 billion a year invested by organized Venture
Capital funds.[citation needed]

Crowd funding is emerging as an alternative to traditional venture capital. Crowd funding

is an approach to raising the capital required for a new project or enterprise by appealing
to large numbers of ordinary people for small donations. While such an approach has
long precedents in the sphere of charity, it is receiving renewed attention from
entrepreneurs such as independent film makers, now that social media and online
communities make it possible to reach out to a group of potentially interested supporters
at very low cost. Some crowd funding models are also being applied for startup funding.
[23] [24]

In industries where assets can be securitized effectively because they reliably generate
future revenue streams or have a good potential for resale in case of foreclosure,
businesses may more cheaply be able to raise debt to finance their growth. Good
examples would include asset-intensive extractive industries such as mining, or
manufacturing industries. Offshore funding is provided via specialist venture capital
trusts which seek to utilise securitization in structuring hybrid multi market transactions
via an SPV (special purpose vehicle): a corporate entity that is designed solely for the
purpose of the financing.

In addition to traditional venture capital and angel networks, groups have emerged which
allow groups of small investors or entrepreneurs themselves to compete in a privatized
business plan competition where the group itself serves as the investor through a
democratic process. [25]

[edit] Geographical differences

( V.C ) Venture capital, as an industry, originated in the United States and American
firms have traditionally been the largest participants in venture deals and the bulk of
venture capital has been deployed in American companies. However, increasingly, non-
US venture investment is growing and the number and size of non-US venture capitalists
have been expanding.

Venture capital has been used as a tool for economic development in a variety of
developing regions. In many of these regions, with less developed financial sectors,
venture capital plays a role in facilitating access to finance for small and medium
enterprises (SMEs), which in most cases would not qualify for receiving bank loans.

In the year of 2008, while the Venture Capital fundings are still majorly dominated by
U.S. (USD 28.8 B invested in over 2550 deals in 2008), compared to International fund
investments (USD 13.4 B invested in everywhere else), there have been an average 5%
growth in the Venture capital deals outside of the U.S- mainly in China, Europe and
Israel[1]. Geographical differences can be significant. For instance, in the U.K., 4% of
British investment goes to venture capital, compared to about 33% in the U.S.[26]

[edit] United States

Venture capitalists invested some $6.6 billion in 797 deals in U.S. during the third quarter
of 2006, according to the MoneyTree Report by PricewaterhouseCoopers and the
National Venture Capital Association based on data by Thomson Financial.

A National Venture Capital Association survey found that a majority (69%) of venture
capitalists predicted that venture investments in the U.S. would have leveled between
$20–29 billion in 2007.[citation needed]

[edit] Canada

Canadian technology companies have attracted interest from the global venture capital
community as a result, in part, of generous tax incentive through the Scientific Research
and Experimental Development (SR&ED) investment tax credit program. The basic
incentive available to any Canadian corporation performing R&D is a non-refundable tax
credit that is equal to 20% of "qualifying" R&D expenditures (labour, material, R&D
contracts, and R&D equipment). An enhanced 35% refundable tax credit of available to
certain (i.e. small) Canadian-controlled private corporations (CCPCs). Because the CCPC
rules require a minimum of 50% Canadian ownership in the company performing R&D,
foreign investors who would like to benefit from the larger 35% tax credit must accept
minority position in the company - which might not be desirable. The SR&ED program
does not restrict the export of any technology or intellectual property that may have been
developed with the benefit of SR&ED tax incentives.

Canada also has a fairly unique form of venture capital generation in its Labour
Sponsored Venture Capital Corporations (LSVCC). These funds, also known as Retail
Venture Capital or Labour Sponsored Investment Funds (LSIF), are generally sponsored
by labor unions and offer tax breaks from government to encourage retail investors to
purchase the funds. Generally, these Retail Venture Capital funds only invest in
companies where the majority of employees are in Canada. However, innovative
structures have been developed to permit LSVCCs to direct in Canadian subsidiaries of
corporations incorporated in jurisdictions outside of Canada.

[edit] Europe

Europe has a large and growing number of active venture firms. Capital raised in the
region in 2005, including buy-out funds, exceeded €60bn, of which €12.6bn was
specifically for venture investment. The European Venture Capital Association includes a
list of active firms and other statistics. In 2006 the top three countries receiving the most
venture capital investments were the United Kingdom (515 minority stakes sold for
€1.78bn), France (195 deals worth €875m), and Germany (207 deals worth €428m)
according to data gathered by Library House.[27]

European venture capital investment in the second quarter of 2007 rose 5% to 1.14 billion
Euros from the first quarter. However, due to bigger sized deals in early stage
investments, the number of deals was down 20% to 213. The second quarter venture
capital investment results were significant in terms of early-round investment, where as
much as 600 million Euros (about 42.8% of the total capital) were invested in 126 early
round deals (which comprised more than half of the total number of deals).[28] Private
equity in Italy was 4.2 billion Euros in 2007.

[edit] China

See also: China Venture Capital Association

[edit] Confidential information

Unlike public companies, information regarding an entrepreneur's business is typically
confidential and proprietary. As part of the due diligence process, most venture capitalists
will require significant detail with respect to a company's business plan. Entrepreneurs
must remain vigilant about sharing information with venture capitalists that are investors
in their competitors. Most venture capitalists treat information confidentially, however, as
a matter of business practice, do not typically enter into Non Disclosure Agreements
because of the potential liability issues those agreements entail. Entrepreneurs are
typically well-advised to protect truly proprietary intellectual property.

Limited partners of venture capital firms typically have access only to limited amounts of
information with respect to the individual portfolio companies in which they are invested
and are typically bound by confidentiality provisions in the fund's limited partnership
agreement.

[edit] Popular culture

Robert von Goeben and Kathryn Siegler produced a comic strip called The VC between
the years 1997-2000 that parodied the industry, often by showing humorous exchanges
between venture capitalists and entrepreneurs.[29] Von Goeben was a partner in Redleaf
Venture Management when he began writing the strip.[30]

Mark Coggins' 2002 novel Vulture Capital features a venture capitalist protagonist who
investigates the disappearance of the chief scientist in a biotech firm in which he has
invested. Coggins also worked in the industry and was co-founder of a dot-com startup.[31]

In the Dilbert comic strip, a character named 'Vijay, the World's Most Desperate Venture
Capitalist' frequently makes appearances, offering bags of cash to anyone with even a
hint of potential. In one strip, he offers two small children with good math grades money
based on the fact that if they marry and produce an engineer baby he can invest in the
infant's first idea. The children respond that they are already looking for mezzanine
funding.

Drawing on his experience as reporter covering technology for the New York Times, Matt
Richtel produced the 2007 novel Hooked, in which the actions of the main character's
deceased girlfriend, a Silicon Valley venture capitalist, play a key role in the plot.[32]

In the TV series Dragons' Den, various startup companies pitch their business plans to a
panel of venture capitalists.

In the 2005 movie, Wedding Crashers, Jeremy Grey (Vince Vaughn) and John Beckwith
(Owen Wilson) are two bachelors who create appearances to play at different weddings
of complete strangers, and a large part of the movie follows them posing as venture
capitalists from New Hampshire.