Private equity: an example of good finance?

At a time when finance is more than ever criticized, when it has become very difficult to distinguish between good and bad finance, at least politically, it is important to recall the interest of the latter. Far too many people tend to forget the indispensable nature of finance in the proper functioning of our economy, in their defence, it is true that the crisis has been there and that the financial sector has many members who are not really involved in restoring its image.

private equity

Mr. Kerviel and Mr. Madoff have not helped things, regardless of what opinion we have of them. There are many examples for those who want to see this activity as harmful and the reasons can be many, but one of the main reasons, and it is obvious, is simply that we will always talk more about the person who accumulates scams in his work than the one who sits 100 hours a week behind his desk without making a wave.

Since the rise of finance in the 1970s and 1980s, it has become so complex that the uninitiated have even come to doubt its usefulness and the relevance of its place in society. They hear about financial markets, hedge funds, risk management, and many other equally abstract and incomprehensible terms as if we wanted to keep them further away from this world apart and this is what makes it obscure and fuels growing mistrust of financiers and their activity.

However, finance is far from the prejudices and fantasies maintained by some people and it is therefore essential to recall its role in an increasingly globalised world where the slightest economic event taking place in New York at 9am has an immediate impact in Paris at 3pm.

Because finance is there above all to finance the economy, an obvious yet often forgotten definition, at all levels, from small businesses to governments and in all geographical areas. It makes it possible to provide and circulate capital to the economic actors who need it to develop. There are also activities that correspond perfectly to this definition and more particularly one: private equity.

What is private equity?

Private equity, also known as private equity, is an activity that is generally carried out through an investment company, which takes stakes in the capital of a company that needs equity capital. These are generally companies whose capital is closed, i.e. not listed on the stock exchange and which cannot therefore call on public money to develop.

There are several ways to invest in private equity, depending on the strategy employed by the investor himself in relation to the situation in which the company finds itself.

The challenges of private equity

Private equity can therefore be broken down into four strategies:

Venture capital or innovation capital:

This strategy consists in investing in companies that are in the project stage or have just been created and need capital to set up their activity, these are generally high-potential sectors such as new technologies or biotechnologies.

We talk about venture capital because it is obvious that investing in start-up companies is dangerous; it is during this period that the new company is most likely to go bankrupt.

The investor’s goal is to obtain a high return with the companies that will develop, allowing him to largely cover the losses caused by possible bankruptcies. In this case, the risk of losing the entire initial investment is relatively high, unlike investments in the shares of large companies, where the risk of bankruptcy is still lower.

In countries other than France, venture capital is sometimes translated as Venture Capital and is therefore perceived more as an “entrepreneurial adventure” than a simple financial investment.

Development Capital:

In this case, it is a question of entering the capital of companies that have already been created and which no longer fall within the scope of venture capital but which need to accelerate their growth through new capital either for internal development by financing, for example, their working capital needs or by increasing the funds allocated to research and development or for external development through acquisitions.

This type of investment presents a lower risk than venture capital since the companies in question already have an activity and therefore a clientele. On the other hand, they have also validated part of their potential, which suggests a lower return on investment.

-Capital transmission:

The investor operates as a mature company and generally seeks to acquire all the capital of the company that the manager(s) are seeking to transfer.

This type of activity helps to prepare the company’s succession.

Turnaround capital:

This investment strategy differs slightly from the others since these are companies in difficulty and the purpose of the capital injection is to save them through a financing plan. The purchaser of the company usually takes control of it in order to be able to make his own strategic choices to save the company.

private equity

The private equity intervention cycle

Source: sicavonline.fr

The role of private equity is therefore to support companies from the creation stage to the end of their life. But then why is this activity sometimes criticized when its purpose is completely in line with the needs of the economy?

Private equity is often poorly perceived by companies and their employees who take a negative view of this entry into capital.

“The intrusion” of investors

Unlike investors in listed companies with significant market capitalization, management companies that invest their funds as part of a private equity activity have sufficient liquidity to have a majority share in the company’s capital, which means that they have the opportunity to sit on the Board of Directors and therefore to participate in the company’s strategic decisions, which can sometimes be interpreted by other employees as an intrusion, an aggressive takeover and above all the end of the human character of the company with financiers now at its head who will only seek profitability and cost reduction.

Once again there are examples, and in particular one going in the direction of a private equity fund manager going to the boards of directors with a coffee cup with a picture of the person who opposed his choices and was fired. It is true that this is possible, but this is a miscellaneous fact and not a recurring phenomenon.

When an investor takes an equity stake in a company, his interest and that of the company are linked and he participates in the adventure on the same basis as all the other employees. Especially since private equity is not a limited activity since in France alone, 5000 companies use this means of financing, which places it in the second position of corporate financing methods. This is undoubtedly the best proof of the role of private equity and, through this activity, of that of finance in general in society.

It is finally difficult to say whether private equity belongs to the right finance or not because, as one might expect, one does not really know whether there is good and bad finance, but perhaps simply finance and its excesses as for each sector of activity.

What is certain, however, is that private equity has a key role to play in the economy and that this practice must be encouraged by the political authorities, who have in their hands all the cards to solve the problems faced by companies.

Benoît Gueguen

Benoît GUEGUEN


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