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What is Private Equity? The Pros and Cons

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Private equity has become more popular in the past few years and has been utilised by many companies to fulfil their plans for growth.

Private equity consists of funds and investments directed to private companies by an investor, who in return will receive part ownership or an interest in the company.  When offering investments to potential new shareholders, companies will be able to raise significant amounts of capital and this option can be used to replace bank loans.

The main reason behind an equity investment for shareholders is the expectation of a return from the investment. When funds are received by the company, managers and directors of the business will aim, through growth plans, to provide a return to the shareholders. The capital funds flowing from the investment can assist companies to buy new technologies to enhance the business, plan an acquisition of a competitor, strengthen their balance sheet etc.

When looking at the possibility of obtaining private equity for a business, various factors should be considered by business owners.

An important advantage is the ability to choose the investors that are going to be part of the business. This is an important consideration for the business owners as they will want to ensure that the new shareholders have the same values and objectives for the company, as well as sharing their knowledge and their assistance. Once a potential investor becomes a shareholder, all the rights attached to the specific position will come into play and decision making power will influence the decisions of the company in general.

Another important factor is flexibility.  Business owners will have the ability to control the investment and the return of ownership to the potential new shareholder. This will be linked to the potential return to the investor in a longer period of time, giving the company and the managers a greater opportunity to use the investment in the company.

It is really important for business owners to ensure that when an investment is requested, the capital is raised quickly, unlike with a public company. Investment rounds can be completed quickly and the money can be transferred to the company in a reasonable amount of time.

At the same time, when considering new investments into the business, business owners and managers should consider certain disadvantages.

One disadvantage is the dilution in the company. When a new investor is introduced, other shareholders will need to accept the dilution of their shareholding and the control of the decision-making procedure of the business. This reduction of control from the shareholders is linked as well to the loss of control from the management. The release of control over the company to another investor can cause loss of basic elements of your business, for example targets and strategy, as well as the choice of the management of the company.

Another important consideration relates to the eligibility requested by the company for specific investors. When capital investments are made into a company, the investors will look into the potential of the business, the contracts and work planned for the future, the financial position and the experience that they can bring to the business, but most importantly a lucrative return and a potential exit in the future.

One last consideration is related to the limited market that will be available and the limited number of potential investors in comparison to the public exchange. Investors might not be interested in a small return from a private company, which means that the investors might not provide a big investment.

As in every business venture, there are pros and cons that will need to be evaluated by the parties. The factors above will need to be taken into consideration to ensure that the investment is balanced with the presence of a new person in the business.

The information contained in this article is for information purposes only and is not intended to constitute legal advice. If you require further information, our commercial team would be more than happy to assist you. Please contact us at [email protected] or call us on 029 2009 5500 to speak to one of our team.