Welcome Pack

A Beginners’ Guide
to PE and VC
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Contents

What are private equity 03

and venture capital? >>

Why are private equity and 04

venture capital important? >>

How it all works >> 06

Types of investment >> 10

Job titles and responsibilities 12

Commonly used words
and phrases >>

Official BVCA investment 18

stage terminology >>

Further reading >> 20

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What are PE and VC?

Private equity and venture capital

For people who do not work in the finance industry, the world of private equity (PE)
can seem somewhat daunting. There are numerous acronyms and even trying to
explain what private equity is can be mind-boggling. So, in its simplest terms, what
is private equity?

Private equity is a type of investment.

Private equity and venture capital firms (or funds) invest money by buying all, or
part of a business with the intention that this business will grow in value and can be
sold at a later date for more money than the business was purchased for.

Private equity (PE) and venture capital (VC) firms will seek to make a profit (known
as a return on investment) by growing and improving the company, using not only
finance but also their own commercial expertise and business acumen.

A large variety of businesses in different industrial sectors benefit from private

equity and venture capital investment, including those operating in technology,
manufacturing, healthcare, consumer services, financial and other business areas.

Here are some famous names you may know, all of which are backed by
UK private equity and venture capital

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Why are PE and VC important?

It isn’t just investors that benefit from private equity; our industry
delivers for institutional investors and for the wider economy,
providing investment, employment, driving innovation and building
British businesses. It is, quite simply, funding the future.

2 million people
employed in the UK by companies backed
by private equity and venture capital

1,320 UK companies
received investment from private equity
and venture capital in 2021

5,000+ businesses
currently backed by UK private equity
and venture capital

9 in 10 investments
directed at SMEs (small to medium-sized enterprises)
from private equity and venture capital in 2021

£17.3bn invested
into UK companies from private equity
and venture capital in 2021

£16.7bn raised
from private equity and venture capital in 2021

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Why are PE and VC important?

Private equity firms generally invest in large, well-established companies, whilst

venture capital firms invest in start-up/early stage companies. Both private equity
and venture capital firms usually only invest in unquoted businesses; this means the
company is not listed on a stock market and therefore cannot sell (trade) part or all
of its investment on a daily basis. This is referred to as being illiquid.

(It should be noted that the terms ‘private equity’ and ‘venture capital’ are often
used interchangeably, particularly in the media. Often ‘private equity’ is used to
refer to both private equity and venture capital, and conversely the same also
happens with the term ‘venture capital’).

The time duration for each investment varies but, generally, it will last between
four and seven years before the PE or VC firm sells the stake it has acquired. This
means there is a commitment to each and every business by building lasting and
sustainable value. It is without doubt that creating value in a business is key to the
private equity and venture capital model.

So where do PE and VC firms

obtain the money to invest in
these businesses?
Private equity and venture capital firms raise
funds to buy businesses from institutional
BVCA Report on
investors like pension funds, insurance
companies, sovereign wealth funds and family-
Investment Activity
offices. For these investors, private equity
and venture capital is an “asset class” which
has consistently delivered strong returns
and continuously outperforms other asset
classes, including stock markets. Its ability to
produce returns even during times of economic
downturn makes private equity and venture
capital very attractive to investors.

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How it all works

Private equity and venture capital are different but both share
some essential similarities in that firms raise money from
institutional investors, they pool this capital (money) into funds,
and then they use these funds to invest in companies for an
equity stake which they will eventually sell. The profit made
from this sale is then returned to the investors in the fund.

The primary difference between private equity and venture capital is the
type of companies they typically invest in. Venture capital firms are generally
interested in backing young, early-stage companies whilst private equity
will be looking for more mature and more established businesses.

VC firms will generally take a minority equity stake (<50%) in a company –

often alongside other venture capital firms – whereas private equity firms will
generally take larger stakes, often acquiring a controlling majority share (>75%)
and buyout the entire business. At the same time as a private equity firm makes
an investment in a company, it will use bank debt or other debt capital raised
alongside its own equity to ‘leverage’ its investment to fund the acquisition.
‘Leverage’ is simply another term used to mean debt borrowed from a bank (or
similar institution). One way to think of it is like buying a house: the buyer will
invest their own money (as equity) for a certain percentage of the total cost of the
house and then borrow the rest from a bank in the form of a mortgage (debt).

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How it all works

Venture capital firms will generally hold onto an equity stake for a longer period
of time than a private equity firm due to the nature of investing in early-stage
businesses, which can often take a long time to grow and start making a profit.

In between private equity and venture capital is an increasingly important type of

investment called growth capital. Broadly speaking, firms specialising in growth
capital will invest in companies that are more mature than those acquired by a
VC firm, but the businesses are not yet mature enough for a private equity firm.
A growth investment will be used to develop a particular area of the business.

Despite these differences, every equity stake, be it from a VC firm or a PE firm, will
at some point be sold. The goal over the course of the investment – or ‘hold’ – period
is the same: to ensure the business has improved over that time and is more valuable
at the end of the hold period than at the start of the investment. This increase
in value could be because the business has increased profits, acquired other
businesses, expanded into new markets or overseas, or launched new products.

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How it all works

Time to exit
Once a company is in such a position, there are a number of options for a
private equity or venture capital firm wishing to sell their stake or ‘exit’
their investment.

Firstly, they may sell their stake to another company, generally to a larger
one than the one being sold. This is known as a ‘trade sale’. For example,
if you have a great tech start-up, you may wish to sell this to a company
like Google or Apple.

A second option is to list (put) the company on the stock market, also called a ‘float’
or ‘IPO’ (Initial Public Offering). By listing the business on the stock market, the VC
or PE investor will typically sell part of their stake on the first day the company ‘floats’
and then they will sell off the rest of their stake over a period of time.

A third option is to sell to another venture capital or private equity firm. This rarely
happens with venture capital – although sometimes venture capital firms will sell to
private equity firms – but it is quite common for private equity firms to sell to one
another. This is known as a secondary buyout and will typically involve a smaller
private equity firm selling to a larger private equity firm who will help the company
grow even further.

Skin in the game

One of the most important aspects of the private equity and venture capital
model is the fact that the PE and VC firm will invest its own money into its
funds alongside that of the capital raised from institutional investors.

This is to ensure the fund manager – or ‘General Partner’ (GP) in industry jargon –
has ‘skin in the game’, i.e. that they are sufficiently motivated to make the fund as
successful as possible. If you want to get technical, the phrase for this concept is
‘alignment of interests’.

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How it all works

All of this capital is put into a fund structured as a Limited Partnership which is then
managed by the General Partner. The institutional investors are also known as ‘Limited
Partners’, or LPs for short.

When the time comes to sell a stake in the company, all of the investors in the Limited
Partnership will, assuming the investment has been a successful one, share in the
profits made. However, it is the LPs – i.e. the pension funds, insurance companies,
etc – who first receive any returns generated. The fund manager – the GP – will only
receive their share of the return when the level of return has surpassed a certain point.
This point is known as the ‘hurdle rate’ and will be agreed between the LP and the GP.
Once the hurdle rate has been exceeded, then the GP will start to take their share –
this is known as ‘carried interest’.

Public ownership versus private equity

Public ownership (when a company is listed on the stock market) has
a number of fundamental differences compared to the private equity
investment form of ownership.

A typical public company will have in the region of 100,000 shareholders, very
few of whom will be able to exert any meaningful influence. A private equity-
backed company, by contrast, will have, usually, just one shareholder (the private
equity firm) in addition to the management team. This usually results in short
reporting lines between the shareholder and management, thus enabling the
private equity-backed business to be agile and make decisions faster, and as such,
the management team can focus on the real issues of running a business. Private
companies also do not have to comply with the regulations that public companies
must adhere to.

Stock markets often undervalue companies because shareholders are unable to fully
support the investment in terms of time and capital which are essential ingredients
for a company if it wishes to deliver its full potential.

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How it all works

Conversely, the private equity industry is often best placed to realise hidden
value from such companies because of the unique way that it owns and governs
businesses and its longer-term investment horizons.

Types of investment
There are a wide range of PE and VC investments but
the most common types of investment are as follows:

Seed and early-stage

As the name suggests, this type of investment is for young (very young in the case
of seed investments) companies and are primarily the domain of “Angel Investors”
and venture capital firms. Seed and early stage investments are often distinguished
by the ‘round’ of investment. ‘Rounds’ are when a company takes on a fundraising
drive to raise capital, often from a number of different Angel Investors or VC firms.

The funding rounds begin with a ‘seed’ investment and is followed by A, B, then C
funding rounds, with the amount of capital being raised increasing on each round.
Sometimes you will also see D and even E funding rounds, but very rarely more than this.

The main differences between rounds of investment are the maturity levels of the
businesses, the type of investors involved, the purpose of raising capital, and how it
is ultimately allocated.

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How it all works

Growth capital

As briefly mentioned above, growth capital sits between venture capital and
private equity. Whilst many early-stage businesses will not yet be making a profit,
growth capital investments tend to be in companies that are in the later stages
of development and are a bit older, larger, generating a profit, and have identified
an area for new business growth that needs additional capital to support the
growth. Growth capital usually takes the form of a minority investment – i.e. not a
controlling stake.

Buyout

There are a number of different types of buyout – management buyout, leverage

buyout, secondary buyout, to name just a few – but the most important thing
to remember is that the term refers to a private equity firm buying a controlling
equity stake in a company. Buyouts range from the acquisition of relatively small
businesses to very large ones, and can involve tens of millions of pounds right up to
hundreds of millions and in some cases billions of pounds.

Please carry on reading to find out more details of the BVCA’s official investment
terminology which is used by our own Research team.

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Job titles and responsibilities

There are a myriad of job titles used among our private equity and
venture capital (GP) members, so many that it can appear confusing
even to a veteran of the industry. To make matters worse, different
member firms often use job titles differently. For example, at one firm
a manager might be a more senior position, whereas at another firm it
could be a more junior one. At some firms, the managing partner is the
head of the firm, at others the most senior positon could be the CEO.

However, there are some commonalities and the below guide – listing titles
from senior to junior - will give you a good indication of how senior someone
is and what their responsibilities are. However, this is just a guide so if you
are ever in doubt, don’t hesitate to ask one of your team members.

Partner
Sets the overall strategic direction and leadership of the fund with ultimate
responsibility for raising funds for investment and delivering the anticipated returns
to investors. Typical job titles may include (but are not limited to) the following:
Managing Partner, Partner, Operating Partner

Investment Director
Works with senior leadership to develop and deliver the fund strategy
Typical job titles may include (but are not limited to) the following:
Investment Director, Director of Private Equity,
Director of Venture Capital, Fund Director

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Job titles and responsibilities

Investment Manager
Works with the senior deal team to deliver the fund strategy
Typical job titles may include (but are not limited to) the following:
Investment Manager, Principal, Fund Manager

Investment Analyst
Sources investment deal opportunities and supports the senior
deal team with fundraising and management of funds. Typical job
titles may include (but are not limited to) the following: Origination
Analyst, Investment Analyst, Associate, Investment Associate,
Investment Executive

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Commonly used words & phrases

As you will shortly discover, if you haven’t already, this is an industry with
lots of jargon and acronyms. Below is a list of some of the most commonly
used terms, but it is in no way comprehensive, so please do not be afraid
to ask a colleague if you come across a piece of terminology you do not
understand, or alternatively check out the BVCA website.

Angel investors Capital

Or business angels. These are high-net Money.
worth individuals who invest their own
money into very young companies in
exchange for an equity stake. Angel Cash multiple
investors will typically invest in younger
and smaller companies than a venture A measurement of the return generated
capital firm. by an investment.

Asset class Carried interest

An asset class is a category of Also known as carry: this is the share of
investment which has similar financial the profits generated by an investment
characteristics and behaves similarly that is paid to the GP.
in the marketplace, for example Cash,
Shares, Property and Bonds. Corporate venture
capital
Assets under
management (AUM) A type of venture capital. Rather than
a standalone – independent – fund,
This means the total value of all the corporate venture capital funds will be
companies a venture capital or private part of a large company and will invest in
equity firm is currently invested in. early-stage businesses on their behalf.

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Commonly used words & phrases

Crowdfunding Impact investment

Type of investment where a business Also known as social investment, or
raises money from a large number of social impact investment. These are
people who each contribute a relatively investments made into companies,
small amount. organizations and funds with the
intention to generate a measurable and
beneficial social or environmental impact
Equity alongside a financial return.

Shares issued by a company.

Institutional investor
Exit See Limited Partner (LP).

When a fund sells its equity stake in

a company. Investee company
A company which is currently invested
Fund-of-funds in by a private equity or venture capital
fund. Also known as a portfolio company.
A fund which raises money from
institutional investors to invest into
private equity and venture capital funds. IPO
Initial Public Offering. The very first
Fundraising sale of a company’s shares to the public
via the stock market. See listed/quoted
When a VC or PE firm raises capital from company.
institutional investors to form a fund.

General Partner (GP) IRR

Internal Rate of Return. A measurement
Another name for a private equity or of the return generated by an
venture capital firm or fund manager. investment. It calculates the return by
looking at all of the cash flows from the
investment over a given time period.

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Commonly used words & phrases

Leverage Management fees

A private equity firm may use leverage These are fees paid by LPs to the GP for
(debt) to purchase a company alongside managing the fund. They are used to
their own investment. A deal using pay for the day-to-day operations of the
leverage is often called a ‘leverage GP, such as salaries, office rent, utilities
buyout’ or ‘LBO’. bills etc.

Limited Partner (LP) Management team

Another name for an investor in private The senior managers of a portfolio/
equity and venture capital funds. investee company, i.e. CEO, COO, etc.
Typically LPs are institutional investors
like pension funds, insurance companies
or sovereign wealth funds. They can also Portfolio company
be Fund-of-funds (see ‘Fund-of-funds’).
A company which is currently being
invested in (or backed) by a private
Listed/quoted equity or venture capital fund. Also
known as an investee company.
company
A public company with shares listed for Public company
trade on the stockmarket.
A company that is listed on a stock
market such as the London Stock
Listed private equity Exchange, New York Stock Exchange,
the Hang Seng (Hong Kong stock
Private equity funds that are listed on market) etc.
the stock market and raise money from
the stock market to invest.

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Commonly used words & phrases

Trade sale Return on investment

When a fund sells its equity stake to Return on investment is a performance
another business, a form of exit. measure used to evaluate the efficiency
of an investment. To calculate the return
on an investment, the benefit/profit (or
Responsible return) of an investment is divided by
investment the cost of the investment.

An approach to investing that aims

Round
to incorporate environmental, social When an early-stage company raises
and governance (ESG) factors into money from VC investors, this is called a
investment decisions to better manage round. Rounds can happen in intervals,
risk and generate sustainable long-term starting with a Seed round followed by
returns. Series A, B and C rounds.

Returns Venture Capital

The profits made by a VC or PE firm Trusts (VCTs)
when they sell an equity stake. There are
a number of different ways of calculating A type of venture capital fund that is
returns but the two most common are listed on the stock market and which
IRR (Internal Rate of Return) and cash invests in small companies.
(or money) multiple.

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Official BVCA investment stage terminology

Here are the official BVCA definitions of the various different

stages of investment in our industry. These phrases are most often
used by our Research team when compiling their reports.

Add-on/Bolt-on/ Growth capital

Build-up/ Acquisition A type of private equity investment
(often a minority investment) in
The purchase of a company by relatively mature companies that are
an existing portfolio company looking for primary capital to expand and
funded by a private equity fund. improve operations or enter new markets
to accelerate the growth of the business.
Bridge equity
financing Later stage venture
Financing made available to a Financing provided for an
company in the period of transition operating company which may or
from being privately owned may not be profitable. Late stage
to being publicly quoted. venture tends to be financing into
companies already backed by VCs.
Typically in C or D rounds.
Buyout
Financing provided to acquire a Other early stage
company, typically by purchasing
majority or controlling stakes. It may Funding provided to companies that
use a significant amount of borrowed have initiated commercial manufacturing
capital to meet the cost of acquisition. but require further funds to cover
additional capital expenditure and
working capital before they reach
the break-even point. They will
not be generating a profit yet.

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Official BVCA investment stage terminology

PIPE Replacement capital

Generally referring to a private Minority stake purchase from another
investment in public equity (PIPE). private equity investment fund or from
another shareholder or shareholders.

Seed
Rescue/Turnaround
Funding provided before the investee
company has started mass production/ Financing made available to an existing
distribution with the aim to complete business, which has experienced
research, product definition or financial distress, with a view to
product design, also including market re-establishing prosperity.
tests and creating prototypes. This
funding will not be used to start
mass production/distribution. Secondary Buyout
Financing provided to acquire a company
Public to Private from another private equity firm. It may
use a significant amount of borrowed
Purchase of quoted shares with capital to meet the cost of acquisition.
the purpose of de-listing the
company from a stock exchange.
Start-up
Refinancing Funding provided to companies, once the
product or service is fully developed, to
bank debt start mass production/distribution and
to cover initial marketing. Companies
Funds provided to enable a company to may be in the process of being set up or
repay or restructure existing bank debt. may have been in business for a shorter
time, but have not sold their product
commercially yet. The destination of the
capital would be mostly to cover capital
expenditure and initial working capital.

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Further reading

If you still want to know more about private equity and our
industry why not visit some of the websites below.

BVCA website
www.bvca.co.uk

A Guide to Private Equity

Dated in parts (it was published in 2012) but still good on the essentials

Finance Hub
A British Business Bank website for businesses seeking investment

The Business Finance Guide

A dedicated microsite from the British Business Bank

Private Equity Demystified

By the Insitute of Chartered Accountants in England and Wales (2014)

Private Equity Made Simple

by the trade association for pension funds (2014)

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