There are two ways to finance a business: private equity and private debt. Choosing what is best for you varies on personal requirements.
Private Debt vs Private Equity
The main difference between private debt and private equity is the source from which the money is obtained and the extent to which that money is used.
Private equity allows various investors to invest in small, young firms that could be advanced and improved and can later be sold at a high price. This is done to obtain large scale profit.
Whereas, private debt is a form of loan: informal and formal. The debt does not allow huge investment in the company, and the profit turns low. It is provided by an individual or company, depending upon the relation of the debtor and the creditor.
Comparison Table Between Private Debt and Private Equity (in Tabular Form)
| Parameter of Comparison | Private Equity | Private Debt |
|---|---|---|
| Role of Interest | These companies look for young firms and undervalues companies to invest in, develop them, resell and obtain profit. | A personal loan, credit card, corporate bond or business loan taken from an individual or private investors. |
| Source | It is obtained from private investors and companies who buy small firms | Debt can be obtained from a relative, friend or even a private company |
| Investors incentives | After the company or firm has transformed, it catches the eye of various investors who are ready to make large scale investments on the newly arising company. This allows the original equity holders to obtain large scale profit. | For investors that are contributing debt to your company, there may be less incentive to work as hard to grow the business than if the investor was a equity holder. This is because the debt holders are first in priority to receive funds in the case after liquidation, so they do not have any incentive to grow the business. |
| Cash and Other Requirements | It required large amount of cash for investment. It require expertise and skills to evaluate which company is ideal for investing and the profit that could be obtained from it’s reselling. | In this, the company has to regularly make payments to the debt holder along with the interest. This leads to severe drainage of cash. |
| Liability on Balance Sheet | Equity doesn’t show up as a liability on your balance sheet. Though you have to disclose other equity holders in your financial and corporate documents. | It is a liability on the company and on the balance sheet. Investors may be hesitant to invest in a company that has too much liability on its books. |
What is Private Debt?
Private debt is the debt accrued by individuals or private businesses. Private debt can be obtained in diverse forms varying from a personal loan, credit card, corporate bond, or a business loan. It also involves non-banking institutions that takes loan from private companies.
On a large scale, a large number of investors are involved in the process. Direct lend, mezzanine, distressed debt, infrastructure, and real estate, are included in the same.
Private debt is risky because when a loan is provided within the family or between friends, irregular repayments can cause tension and even result in a conflicting relationship. The debtor is not the only one who has the risk of private debt. The creditor is also a menace for non-repayment of funds or expensive legal formalities when they agree to make a loan. If a situation of bankruptcy arises, a debtor will lose a major share of the investment.
What is Private Equity?
Private equity has grown significantly in the past 20 years. It is an unconventional investment class that comprises of assets that are not listed on a public exchange.
In this the funds and investors actively invest in private firms. They even take part in the buyouts of public companies. This leads to the disposal of public equity.
The main idea is to use the money to acquire private or public companies, develop and improve their business and resell it at a considerable profit. This process generally takes place between 5-10 years but may vary depending upon the company.
Private investors finance various companies and provide them with adequate capital to introduce new technology that would lead to their development, expand the working capital, reinforce and solidify their balance sheet
A private equity fund has Limited Partners (LP), who usually owns 99 percent of shares in a fund and has limited liability, or zero liability whereas the General Partners (GP) owns merely 1 percent of shares and has full liability. The General Partners are incharge of executing and operating the investment and hold great responsibility.
The major target of Private Equity funds is a young firm that seems to have a promising future and sound management. But this is not the case every time, sometimes they also buy businesses that are under-performing and are undervalued by the market.
MAJOR OBJECTIVES
- Private equity is a form of private financing. In this various investors directly invest in companies, develop them and make huge profits after selling them.
- Private equity is risky, very illiquid and the investors expect a much higher return, than the initial investment.
- Most private equity firms narrow themselves down to focus on a certain niche. They can specialize in a given industry like the technical industry, fashion industry, food products, or so on.
- Many of the large investment banks have a private equity arm.
- It is one of the most desired career paths in the world of Business and Finance.
Main Differences Between Private Debt and Private Equity
- Private debt funds can be unrestricted and flexible, whereas private equity funds will mostly be restricted and comes with a deadline.
- Private debt helps to get the returns from interest on loans, while private equity funds tries to generate returns by increasing the value of portfolio of companies and then selling it at a high price.
- Private debt fund becomes a burden on the person as the person has to pay debt with the interest. Whereas private equity is like investment that if carefully selected, can give a lot of profit.
- Private debt is easier to obtain if there are good relations between people. But to invest in a new firm, a lot of study and examination is conducted. Even after that the portfolio of the company is developed thoughtfully.
- The person obtaining the debt is lending others money and living on their cash whereas the firm which is being sold looses the ownership and can no more claim any rights on it.
Conclusion
At the end, both the private debt and private equity plays a crucial role in the development of young firms, that are looking for expanding themselves. Both work on a profit basis, though a lot of risk is involved. All these private ownership brings benefit to few while giving opportunity to many.
References
- https://www.federalreserve.gov/pubs/feds/1996/199625/199625pap.pdf
- https://epublications.marquette.edu/cgi/viewcontent.cgi?article=1028&context=fin_fac