There are a few features that distinguish PE/VC investing from other types when buying a business. It’s important to pay attention to these differences. Knowing these facts will save you from a lot of wasted time and frustration and avoid going down the wrong path.  

 

The PE/VC professional will be actively involved in identifying the investment, negotiating and structuring the sale and monitoring the portfolio business after the investment has been made. Often, that person will serve as a board member and/or financial advisor to the portfolio company. This contrasts from a money manager that will passively select and retain stock and debt investments.  

 

Unlike other kinds of investments, those that are private equity or venture capital are not intended to be held for an indefinite period. Rather, they are to be held for a limited number of years with the expectation that there will be substantial growth in value following the sale.  

 

For example:        

• A PE/VC fund ordinarily has a limited term of usually 10 to 13 years, where it goes through cycles.
  
• PE/VC investments are generally made during the first 5 years with value-added monitoring and growth continuing for several years thereafter.
  
• Most investments are sold within 3 to 7 years after the original one in the portfolio business.
  
• All investments are sold or distributed in kind to the investors within 10 to 13 years after the funds formation  
  

The PE/VC investor normally does not intend to maintain long-term control over the portfolio business or to build a career running it. Rather, they generally evaluate alternative exit strategies when making the initial investment. Often, the original investment documents contain the terms or at least the outline of the PE/VC investor’s anticipated exit strategy. Hence, PE/VC investing is significantly different from buying a company with the intent of managing it for the indefinite future and profiting indefinitely from the operating cash flow produced by the business.            

 

Privately-Held Purchased Securities 

Instead of being publicly traded, securities that are purchased through PE/VC investing are generally held privately by a small group. When a PE/VC puts together a new business start-up, the newly-formed company (“Newco”) is privately held at the outset most of the time. If the target in a buyout is publicly-held before it takes place, the new company formed to effectuate the buyout (“Newco”) is almost always held privately immediately thereafter.  

 

Where a PE/VC makes a growth-equity investment in an existing company (“Oldco”), it’s usually held privately. In those few circumstances where a PE/VC makes a growth-equity investment in a publicly-held Oldco, the PE/VC generally buys a class of Oldco securities that is not traded publicly.  

 

For example, where Oldco’s common stock is publicly traded, the PE/VC may buy their:  

1. Convertible preferred stock or subordinated debentures that’s convertible into Oldco common stock;
   
2. Non-convertible preferred stock or subordinated debentures with warrants to purchase Oldco common stock.  

Even when a PE/VC investor infrequently buys garden-variety Oldco common stock that’s publicly traded, they typically acquire such stock from Oldco in a private placement subject to SEC restrictions and with special negotiated rights that make the PE/VC’s stock different from Oldco’s publicly-traded common kind.  

 

These include:  

• Registration rights;
  
• Pre-emptive rights;
  
• Options or warrants to buy additional Oldco stock at a fixed price;
  
• One or more board seats.  

To summarize, a PE/VC investment is normally made in a privately-held business. In the relatively infrequent cases where the investment is into a publicly-held one, PE/VC will generally hold non-public securities.             

 

While a PE/VC’s exit strategy often involves taking the portfolio business public and ultimately selling the PE/VC’s stock into the public market, trading of the portfolio company’s stock is generally part of the game, not the opening maneuver. Therefore, PE/VC investing is considerably different from buying, holding and selling publicly traded equity securities.  

 

State of Management Status Determines Decision to Invest in a Portfolio Company         

A PE/VC investor will only devote in a portfolio business after confirming that they have a superior management team in place – or one has been recruited. No one can induce the PE/VC investor to put their money behind a management team that has received no vote of confidence, regardless of how attractive the product, concept or business may be.  

 

Therefore, an attractive portfolio company has to have 3 key qualities:  

1. Superior management;
   
2. Superior management; AND
   
3. Superior management.  

To put the point simply: PE/VC should never back a portfolio company with weak management.  

 

A PE/VC investor will often seek control of a given portfolio business early on or at the very least have board representation if nothing absolute is obtainable. The reason for this lies from the view that the PE/VC investor sees itself as providing important advice on financial and strategic planning and oversight for the portfolio company’s management. This will add value to the investment on top of simply supplying capital alone.