Chapter 10
Venture Capital and Private Equity
When investors speak of alternative investments, they often mean hedge funds or private equity rather than other alternatives to stocks and bonds like real estate or commodities. Private equity differs from hedge fund investments in several ways. First, private equity gives the investor privileged access to ownership in an enterprise that is not publicly available. Hedge funds, in contrast, typically invest in publicly available securities. Second, private equity requires long lock-up periods for investment to give time for the enterprises to mature. Hedge funds may have lock-up periods, but these are limited usually to one or two years rather than a decade.
Private equity encompasses several different types of investment types.1 At one extreme, there is venture capital, the investment in enterprises at early stages of their development. A typical venture capital (VC) firm takes only a minority stake in the new enterprise. At the other extreme are buyout firms that take over public companies, then refinance and reorganize them before selling them back to the public. These buyout firms, which represent the largest category of private equity, typically take majority ownership and control of the enterprise. In between VC and buyouts, there are mezzanine investments that can either be late-stage VC investments or highly leveraged buyout transactions. The key characteristic of mezzanine investments is the use of subordinated debt (junior ...
