Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 22 Introduction to Private Equity

Private equity is defined broadly in the CAIA curriculum, to such an extent that some securities that are not equity and some securities that are publicly traded are included in the category. Private equity is used in the CAIA curriculum as a generic term to encompass four distinct strategies or asset groups. First, there is venture capital (VC), the financing of start-up companies. Second, there are buyouts, where established public companies are converted into private companies. Third, there is mezzanine financing, a hybrid of private debt and private equity financing. Last, there is distressed debt, investments in established (as opposed to start-up) but troubled companies.

Private equity is as old as commerce itself. Virtually every major enterprise began as a small, unlisted firm. Private equity is a long-term investment process that requires patience, due diligence, and hands-on monitoring. From a more general perspective, private equity provides the long-term equity base for a company that is not listed on any exchange and cannot raise capital via the public equity market. Private equity provides the capital investment and working capital that are used to help private companies grow and succeed.

The payouts to most private equity investments resemble the payouts to long positions in out-of-the-money calls: The risks are great, but the potential rewards are even greater. This call option view of private equity from the perspective ...