What is private capital? Private capital includes all forms of long-term capital other than publicly traded equity or debt. For the purpose of this overview, we are setting aside publicly traded common and preferred shares and publicly traded debt such as secured notes or high-yield (also called “junk”) bonds as well as crowd funding.
Providers of private capital include high net worth individuals (sometimes called “Angel” investors), venture capital companies, private equity, cashflow or mezzanine term financing, venture debt, family offices and hedge funds.
There are many options in addition to bank operating and term loans to fund and capitalize a company. Cost increases with risk and the riskier the capital the more demanding the level of due diligence, documentation and monitoring costs.
When it comes to private capital, here are some observations to consider:
- Angel investors tend to be seed/early stage investors in start-ups right behind the “friends and family” round. Angel investors often group together and when each invests $25,000 to $200,000 can form seed rounds of $1 million or more.
- The two big camps of private capital are Venture Capital (VC) and Private Equity (PE). VC and PE are different in that venture capitalists take early stage minority equity positions to help high-potential companies grow, whereas private equity take control positions (i.e. more than 50%) in more mature companies and generally deploy a buy-and-build strategy to create value. Both VC and PE will look to exit their investment in 3 to 7 years.
- Many investment fund companies have both PE and VC funds so you can’t necessarily distinguish them by company name.
- Every fund has different and distinct investment criteria that leverage the team’s unique skills and backgrounds. Criteria will address industry niche, investment stage, investment size and business model to name a few.
- Corporate venture capital is a subgroup within VC where the fund is back by a single company. Corporate VCs are created to de-risk Research and Development and also render it more agile. Corporate VC funds can provide access to customers and accelerate product/market fit. Examples of corporate VCs include Intel Capital, Google Ventures, Qualcomm Ventures, and Salesforce Ventures.
- The first VC round is called a series A. Series B and C are traditionally growth and pre-IPO rounds, respectively. In some cases there are series D, E, F etc. but that is usually a sign of a closed IPO window or some other exit strategy in play.
- Most VCs don’t look for profitability as a pre-condition to investment. VC investments are more concept investments around a vision of market potential but VCs will look for metrics indicating future profitability such as high revenue growth, high gross margins, or substantial traction in users/customers.
- PE’s need to see some level of profitability. At the low end it is $1M to $2M and liquidity – i.e. the amount of parties participating – greatly increases as EBITDA exceeds $5 Million.
- Many PEs are SBICs, or Small Business Investment Companies, which are privately owned and managed investment funds that are licensed and regulated by the U.S. Small Business Administration (SBA). SBICs cannot invest in Canadian companies.
- SaaS revenue lending, or recurring revenue financing, provides capital in multiples of the portion of revenue that is predictable and stable called Monthly Recurring Revenue or MRR. The multiple is typically between 4x and 7x MRR and total available funds automatically increases as MRR grows. The minimum MRR is $100,000 to $250,000 depending on the lender. Companies that provide these types of loans include select commercial banks and specialized technology company lenders such as SaaS Capital.
- Venture debt is a bridge loan (to bridge between equity rounds) provided to equity investor backed companies as non-dilutive growth capital. An example of a venture debt company is Espresso Capital.
- Mezzanine or subordinated, or cashflow based loans are unsecured term loans based on a multiple of EBITDA. For example, if a bank will issue a term loan at 3 times EBITDA, the sub or mezz loan can add a turn (i.e. amount equal to EBITDA) at a premium price. Companies that provide these types of loans include the BDC and First West Capital.
- Family Offices can be like VC or PE but differentiate themselves by typically having much longer hold periods (some saying they will never sell) and also by the specific value add they provide from the experience of the family. An example of a family office is Celina Capital.
- Family Offices are sometimes confused with family foundations. Many wealthy families have both, the latter focusing on charitable work.
- Hedge funds, for the most part, invest in public securities. Hedge funds are different from mutual funds or ETFs in that they are not restricted by rules that exist to protect the general public. Hedge funds are available to accredited or qualified investors and their strategies can include: global macro, directional, event-driven, market neutral, and relative value (arbitrage). I have included hedge funds here because some invest in pre-public private rounds (pre-A) but this is typically a small portion of their investment interest.
- Many Family Offices and Hedge funds are very private and do not identify themselves as such on their websites. Many do not have websites at all.
The World of Private Capital is Very Large and Highly Diverse
The world of private capital is very large and highly diverse and that is a good thing. There is so much capital in the private market that it is no longer a requirement to go public to secure large amounts of capital or provide liquidity to founders. In fact, with the amount of regulatory oversight on the public side, many companies prefer to stay private.
The other aspect of private capital is that it is private in the sense of not actively marketing or advertising their existence and appetite. Private capital finds its targets, its investee companies, rather than the other way around. That is where a well-connected broker still earns his/her stripes.
Recommended Further Reading
For more on the process of raising private capital, see: Raising Capital? Prepare Well in Advance
For more on Private Equity, see: A Second Bite at the Apple [the Ideal Private Equity Scenario]