A private equity market is a source of financing for many different companies. Private equity instruments do not trade on a traditional exchange, such as a stock market. Two common types of private equity are venture or growth capital. These funds allow for the expansion of a firm, with borrowed funds repaid at a future date. This equity market can also include sources of financing for leveraged buyouts through the use of mezzanine capital. All types of companies can use the private equity market.
Venture capital includes funds from wealthy individuals or investment groups that give start-up capital to new business ventures. While established businesses can use venture capital, new start ups are typically the primary users. Through the private equity market, entrepreneurs and small business owners can enter contractual agreements for using these funds, including terms for interest rates, repaying the funds and any other terms that need to be addressed through the agreement.
Growth capital is similar to venture capital as individual investors or investment groups will offer money to companies for expanding business operations. The difference between the two is that established businesses use growth funds more than start ups. Terms may be slightly different, as established businesses typically have more stability to repay funds in the future. Therefore, equity funds tend to have a higher probability of full repayment.
In the private equity market, many companies look for available capital as part of the leveraged buyout process. Leveraged buyouts occur when an individual, investment group or other company purchases a controlling interest in a business’s operations. External funds are often necessary for this transaction, as most buyers do not have the available capital on hand for such a large purchase. In terms of borrowed capital, collateral for the loan is the company or specific assets purchased by the buyer. If the buyer cannot generate profits sufficient for repaying the borrowed funds, the lender will receive the assets as payment in lieu of cash.
Mezzanine capital represents a specific type of loan obtained through the private equity market. This equity financing includes junior loans or financing given to a company outside of its traditional or regular financing. Mezzanine financing is not often preferable in some business situations. These loans tend to have higher interest rates or stricter repayment terms as mezzanine lenders incur more risk if the company cannot repay the loan. However, this lending process allows companies to secure short-term loans for unexpected needs or a quicker source of capital than traditional equity markets.