The Handbook of Financial Instruments

Chapter 26 Private Equity

Mark J. P. Anson, CFA, Ph.D., CPA, Esq.

Chief Investment Officer CalPERS

The private equity sector purchases the private stock or equity-linked securities of non-public companies that are expected to go public or provides the capital for public companies (or their divisions) that may wish to go private. The key component in either case is the private nature of the securities purchased. Private equity, by definition, is not publicly traded. Therefore, investments in private equity are illiquid. Investors in this marketplace must be prepared to invest for the long haul; investment horizons may be as extended as 5 to 10 years.

“Private equity” is a generic term that encompasses four distinct strategies in the market for private investing. First, there is venture capital, the financing of start-up companies. Second, there are leveraged buyouts (LBOs) where public companies repurchase all of their outstanding shares and turn themselves into private companies. Third, there is mezzanine financing, a hybrid of private debt and equity financing. Last, there is distressed debt investing. These are private equity investments in established (as opposed to start-up) but troubled companies.

VENTURE CAPITAL

Venture capital is the supply of equity financing to start-up companies that do not have a sufficient track record to attract investment capital from traditional sources (e.g., the public markets or lending institutions). Entrepreneurs that develop business plans ...