Private equity is finance provided in return for an equity stake in potentially high growth companies. However, instead of going to the stock market and selling shares to raise capital, private equity firms raise funds from institutional investors such as pension funds, insurance companies, endowments, and high net worth individuals. Private equity firms use these funds, along with borrowed money and their own commercial acumen, to help build and invest in companies that have the potential for high growth.

Venture capital refers to funds used to invest in companies in the seed (concept), start-up (within three years of the company’s establishment) and early stages of development. In turn, private equity denotes management buyouts and buy-ins.

In general venture capital funds invest in companies at an early stage in their development when they often have little track record of profitability and are cash-hungry. In contrast, private equity funds invest in more mature companies with the aim of reducing inefficiencies and driving business growth through often increased margins and/or new sources of revenue growth.

The ultimate aim of private equity investors is to create value. As such, they look for high quality management teams with a credible plan to grow their business. Private equity investors are long-term investors and work with the company’s management to improve the company’s performance and strategic direction by aligning incentives, improving business plans, making operational improvements and strengthening corporate governance. With this mentality to buy and help build, coupled with a disciplined approach to organisational governance, private equity investors display a nimbleness and adaptability that raises the value of their investment and ensures that value can be realized in the future.

Generally private equity seeks to create value over the long-term, whereas hedge funds have a shorter horizon more in line with movements in the stock markets. Private equity investors usually buy and own all of a company and so have a strict alignment of interests with the managers of the company – this ensures the investors and the company achieve its growth potential over time and indeed they only succeed if the company does well and their investment can be realised.

Hedge funds are pools of capital that invest in stocks, bonds or commodities and do not usually purchase a controlling interest in a company. Hedge funds try to capitalize on short-term market movements, using complex trading strategies involving options, derivatives and other financial instruments. In some cases, hedge funds bet against the shares of the companies they do not own (i.e. short selling), hoping to profit from falling prices.