Private Equity for Small Start-Ups

Though investors have been buying and selling businesses since the industrial revolution began, private equity capital investment is a relatively new area in business investment and funding. The first true private equity firms started in the U.S. at the end of World War II to help military service members returning from the war secure investment funding for small business startups. Today, private equity companies fill an important roll in the small-business startup world that would otherwise be a gap in funding opportunities for the entrepreneur.

Commercial lending institutions provide funding to many of the largest corporations in the world and are accustomed to a level of investment risk, but they are not a viable option for start-up businesses seeking investment capital. Commercial lenders are understandably put off by the risk an entrepreneurial operation poses for an investor. After all, the commercial lender is only receiving interest on their principal loan amount. The small business start-up generally has little if any history in the marketplace and few if any assets to secure funding; they are by definition high risk ventures. They obviously cannot issue debt to raise money and they usually have no other access to the capital market, so what other options are available? This is where private equity investment institutions have come into play.

Private equity firms do not loan capital to small business startups with the expectation of receiving interest in return. Instead, private equity firms invest funds in the business itself. This type of investment normally comes in the form of venture capital, sometimes referred to as “risk money.” Because of the risk involved, venture capital comes with a much higher cost to the business owner. Not only will the lender be providing the capital, they will own a portion of the business in which they are investing. Further, with this kind of funding, the private equity firm will usually have a vote in company decisions, often times providing business expertise, pronounced personnel, to help make business decisions that will affect the potential success of the company.

Contrary to appearances, this is a symbiotic relationship; both the investor and the business owner benefit in these transactions. The startup company receives the capital they need to get off the ground and a vote of confidence that their plan, model or idea has merit and a chance to succeed. From the owner’s perspective, the equity firm has as much or more motivation to see the business succeed and is there to provide help through every step of the process. Providing the business expertise can be seen as freeing the entrepreneur to focus on building his product brand and getting the product to market. Lest anyone think that this is a small time operation, 11% of the jobs and 21% of the U.S. GDP come from venture capital startups. (National Venture Capital Association) Much of this funding is provided by private equity sources.

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Obtain further investment insights from David Hand Crescent Point Asia and Crescent Point Private Equity, the leading emerging markets investment management and financial advisory firm primarily focused on the Asia-Pacific and Middle East regions.