Financial Markets: Part 3 - Private Equity

So far I have covered the first three channels that private companies used to obtain capital. To recap, the first three were: 1. Angel Investors 2. Venture Capital and 3. Private Placements. Numbers four and five are private equity and IPO's.

4. Private Equity (PE) is equity capital that is not used on a public exchange. It consists of private investors and funds who invest directly into private companies for long periods of time (2-5 years is typical). The funding comes from limited partners (LPs) such as retail and institutional investors. PE firms can also buyout public companies resulting in the company becoming private. The capital provided is meant to strengthen the company to accelerate growth to facilitate an exit sometime in the future.

A typical investment amount for such a transaction can range from $20 - $500 million. When investing, PE firms often use leveraged buy outs (LBO). This is when only a portion of this amount used to purchase the asset is actual capital from the PE fund (maybe $4 million) and the rest is borrowed from banks which leverages the deal (maybe $16 million). Say the PE firm can successfully grow the company while paying off the debt and eventually exit after doubling the value on a $20 million dollar company. Then essentially have made a $36 million dollar return on an initial $4 million investment.

When the time does come for the private equity firm to exit the investment they will engage in an initial public offering which I will expand on more tomorrow.

Again, thank you for reading. If you have any questions be sure to leave them in the comments below.

-JS

Financial Markets: Part 2

In part 1 of this series I explained the various steps of funding for a company and left off at number two: venture capital (VC). 

2. Venture Capital: VC firms generally take on more risk in exchange for higher possible return. VC funding is popular for companies with limited history that are unable to do debt offerings. The company often has to give up a portion of the equity in the deal and in exchange receive expertise, introductions, and connections from the veterans at the VC firm. The amount that a VC firm will invest greatly varies but is usually somewhere between $500,000 and $10 million and rarely goes above $20 million. 

3. Private Placement: PP can come before or after venture capital investments and is a way for companies to sell securities to a limited number of investors. Investors usually include large banks, mutual funds, pension funds, etc. As the name suggests the capital raise is private and only announced to the public after the deal has gone through. Public companies with more resources often sell bonds to achieve the same effect but because of the smaller size of most private companies private placements are much more common.  

Just over 5,000 companies have completed private placements so far this year (Jan - May 2013) with an average amount of $7.64 million raised on each transaction. See the trends for the last five years here.

Tomorrow I will write about the capital raising step that often follows venture capital and private placement - private equity. Thanks for reading.

-JS

Why Smaller Investment Banks Talk The Most About Money

It comes down to one thing: prestige. 

Investment banking is a very elitist business, they hire graduates from ivy league schools, work with the top companies in the world, and make abundant amounts of money. All of these things add to the prestige of an individual bank. For this reason it is less likely to hear numbers being thrown around at a Morgan Stanley or a Goldman Sachs. They have the top schools and companies and since this is well known there is little need of a self boost from the numbers.

On the other end of the spectrum this explains why a smaller bank would be more prone to 'talking shop'. They work in the same industry and therefore also make good amounts of money, but their analysts and associates might not all be HBS graduates or the companies they work with may be smaller. Therefore, they gain prestige by talking about the money changing hands during their deals. 

This does not mean one is better than the other, just an observation from someone who has been on both sides.

-JS

Financial Markets: Part 1

For my maiden post I would like to work through some thoughts on the financial markets from 30,000 feet.

Financial markets consist of capital markets and money markets. The latter refers to short term debt a company takes on for generally less than one year (deposits, collateral loans, etc). Commercial and central banks are involved in these transactions. While capital markets consist of any long term debt or financing a company takes on to prepare for an M&A process, expanding into a new market, etc.

While money markets are limited to commercial and central banks, many types of capital markets exist that I would like to expand on.

There are five main channels that private companies naturally progress through to receive capital and grow.

1. Angel Investors: Angels are individuals who provide seed money to companies at their earliest stages. This is the first funding that takes place and also has the most risk.

2. Venture Capital: Shortly after receiving some seed money a company could typically raise money from an interested VC firm.

To Be Continued Tomorrow... I will be posting everyday so stay tuned.