INTM580010 - Thin capitalisation: private equity: What is private equity?

There is no universally accepted definition of the term private equity and there is often confusion between the terms “private equity” and “venture capital”, as the two are used differently by different people. In this manual, we use the terms as follows:

• Venture capital describes an equity investment in a business at the start up and early development stages. See also INTM581030.
• Private equity refers to management buyouts, buy ins and similar investment structures whereby the private equity house takes an equity stake in a more established business.

These investments will be privately held and funded by investment monies raised outside the public markets. Sources of investment monies include pension funds, funds of funds and wealthy individuals. Private equity funds are pooled investment vehicles, usually structured with a fixed life. A private equity house will raise an investment fund which it will invest in a series of portfolio businesses.

Private equity professionals will go into investments with an exit strategy worked out; there will be criteria for what needs to be achieved before resale and there will be periodic reviews of strategy. Many private equity investments have a duration of three to four years before the investment is realised, though it is impossible to generalise.

In a private equity backed acquisition, the target may be any size from the buyout of a business with value of a few million pounds to the taking back into private hands of a previously publicly quoted company. The most commonly encountered acquisition structure is a management buyout of a business. There is more detail on this at INTM580520.

Normally there will be a clear strategy regarding the investments into which the fund enters and how those investments are realised. That strategy will underpin the whole deal. Typically, investments are held for three to five years, the aim being to increase the value significantly before the business is sold or floated on a stock exchange through a share offering.

Thin capitalisation and private equity

Thin capitalisation may be an issue for businesses that have been the subject of a private equity buyout, because the deal is normally highly leveraged and funded in part by connected party lenders, raising the issue of whether any debt would have been provided on a non-arm’s length basis. There is more detail on this in INTM580050.

Much of the general thin cap guidance covered in earlier chapters of this part of the International Manual, such as the ATCA procedure and working the case is also relevant in a private equity context. However, private equity cases often have particular features which may affect how the case is approached. For instance a private equity buyout is usually financed in part by loans from a third-party lender. This chapter covers some of the features specific to private equity cases.