Private vs Public Equity Securities | CFA Level I Equity Investments

In this article, we’ll dive into the differences between private equity securities and public securities, as well as explore the three main types of private equity investments.

Private Equity Securities: A Closer Look

So far, we’ve discussed publicly-traded equity, which companies issue through IPOs and trade on public exchanges. However, companies can also issue private equity securities, typically to institutional investors via private placements. These securities are not listed on public exchanges, resulting in:

• No active secondary market
• No market prices
• High illiquidity
• Trading through negotiations
• Limited financial disclosures

Because there’s no government or exchange requirement for financial disclosures, firms benefit from lower reporting costs and can focus on long-term prospects without public pressure for short-term results. However, this also means weaker corporate governance due to reduced reporting requirements and less public scrutiny. If the company eventually goes public, investors can enjoy much higher potential returns.

Types of Private Equity Investments

Private equity markets, though smaller than public markets, are growing rapidly. The three main types of private equity investments are:

1. Venture capital
2. Leveraged buyouts
3. Private investments in public equity (PIPE)

1. Venture Capital

Venture capital funds invest in early-stage companies, often through equity, convertible preferred shares, or convertible debt. Although the risk of failure is high, successful companies can yield very high returns. These companies, known as portfolio companies, are often nurtured by venture capital fund managers who sit on their boards or fill key management roles.

Venture capital investments are categorized based on the company’s stage of development, including:

• Angel investing: Capital provided at the idea stage for business plan development and market potential assessment.
• Seed stage financing: Investments for product development, marketing, and market research, often through ordinary or convertible preferred shares.
• Early stage financing: Funds for initial production costs and sales expenses, provided before commercial production and sales.
• Later stage: Investments for expanding production and increasing sales through expanded marketing campaigns, provided when a company already has production and sales.
• Mezzanine-stage financing: Capital for preparing a company for an IPO, bridging the gap between expansion and going public.

2. Leveraged Buyouts

Leveraged buyout (LBO) funds acquire established private or public companies, financing a significant portion of the purchase price through debt. Public companies are taken private after buyouts. Targets should have potential for value increase through management incentives, restructuring, cost reduction, or revenue enhancement.

Two types of LBOs include:

• Management buyouts: Existing management is involved in the acquisition and implements value-add measures.
• Management buy-ins: An external management team replaces the existing team to implement value-add measures on the target firm.

The ultimate objective of a buyout is to restructure the acquired company and profit later by taking it “public” again through issuing new shares to the public.

3. Private Investments in Public Equity (PIPE)

Private investments in public equity (PIPE) occur when a public company seeks additional capital quickly and is willing to sell a sizable ownership position to private investors. This additional capital may be needed for:

• Significant expansion opportunities
• Paying off large amounts of debt
• Coping with distress situations

Depending on the urgency and investment size, the private investor may be able to purchase shares at a significant discount to the publicly-quoted market price.

And that’s all for private equity! This topic is discussed in much greater detail in the course on alternative investments. Up next, we’ll look at non-domestic equity securities.