Private equity is one of the main ways growing companies can secure capital investment. This is one of the options you could think about if you're seeking new equity capital to expand operations or reach the next level.

It offers a valuable source of funding to firms, playing a major role in securing the resources needed to grow.

However, turning to private equity is a big step. It involves handing over some control of your business to investors who may have their own priorities. Therefore, it's vital you have a full understanding of what's involved.

So if you've got questions about private equity, read on. We'll explain how it works, what options are available and the benefits and risks you need to consider.

Private equity is a pool of capital typically available to mature or growing businesses. Private equity firms invest in companies in exchange for an equity or ownership stake. They then look to increase the value of the company through improved business plans, operational enhancements or restructuring its strategic direction.

This is usually a medium-term investment and may involve a private equity firm taking over a company entirely, or purchasing a minority portion of the business. Typically, they generate returns by growing the business and selling on their stake for a profit.

Venture capital (VC), which is intended for very early-stage startups, is sometimes confused with private equity. However, the two shouldn't be conflated, as private equity is aimed at more proven businesses.

Private equity firms don't just provide capital. They also deliver guidance and direction to improve the productivity of the business. Their ultimate goal is to increase the value of the firm in order to make a profit when the time comes to divest.

For many growing businesses, this will be a key step on the road to an initial public offering (IPO). A private equity fund can provide the expertise and the experience to prepare a firm for this step. For other founders, private equity investment will see them stepping back from the business and selling majority or total control to the investors.

Regardless of purpose, it's in the interest of private investment funds to grow the firm and create value for the future.

There are several key stages in any private equity partnership and the process is not complete once contracts are signed. Private equity companies will be directly involved in management and make their profit when they sell their stakes. Clear timelines and exit strategies for this must be considered early.

The key stages in any private equity investment include:

• Sourcing: Private investment firms search the market for potential targets that fulfill their criteria.
• Due diligence: Developing a full understanding of the business. This includes its place in the market, growth potential and any risks that may deter investment.
• Investment proposal and negotiations: This will spell out what stake the private equity fund expects in exchange for their funding and how much operational control they will require.
• Management: Once everything has been signed and investment received, how will the private equity firm be involved in managing the company?
• Divestment: Will set out exit strategies for when and how the investors can exit or liquidate their holdings - such as an IPO or private sale - including any lock-in clauses or triggers for sale.

Private equity isn't a singular solution. In fact, there are several ways to approach this form of funding. This could depend on what stage your business is at, your short or medium-term expansion goals or a need for expertise in a certain area.

There are several types of private equity to be aware of, but three of the most common are:

1. Early-stage funding
2. Growth capital
3. Leveraged buyouts

Let's look at each of these and what they involve.

Early-stage funding

Most private equity funds focus on mature or growth firms. The exception is early-stage investment. This has more in common with VC, as it targets startups and founders. Traditional VC may come in at the Seed or pre-Seed phase, when a firm is little more than an idea. Early-stage private equity, on the other hand, usually targets companies with a viable product and a few initial customers, but which may not yet have turned a profit.

Investors focused on this area are looking for fast growth potential for a medium-term commitment. It can be a high-risk approach for private equity investors to work with unproven companies, but the rewards for success can make it worthwhile.

Growth capital

Growth equity focuses on companies that have become established and are looking to take the step to the next level. The injection of new capital from private equity can help them scale up operations, enter new markets or add new technology or products. This presents a lower risk than early-stage companies as there is already a clear record of success.

There will also usually be a clear purpose for how investments will be used that is set out in the growth plan. Unlike some other forms of private equity such as buyouts, investors in growth capital will usually only hold a minority stake in the business.

Leveraged buyouts

A leveraged buyout (LBO) uses borrowed funds in addition to the private equity fund's own resources to take a controlling interest in a target company. They may target struggling firms and often aim to make changes to the company in order to improve profitability. LBOs are normally aimed at more mature businesses and used by the largest private equity firms. Leveraging creditors' and investors' funds allows private equity firms to afford larger buyouts than they may be able to obtain on their own.

This enables funds to target bigger, proven businesses, which offers strong potential for positive returns. However, a key risk of this strategy is that buyers and their companies have to take on significant debt, which can leave them vulnerable to market fluctuations or business underperformance.

Private equity can offer a range of advantages for businesses seeking new funding. This can be a great source of investment if you know what needs to be done to get to the next level. It can also help you prepare for the long term by opening new connections or accessing additional markets, while also providing a degree of security.

Access to capital

The main advantage of private equity for most firms is access to capital. This is about more than just securing funding. Private equity can inject resources into a business quickly and flexibly. This allows firms to respond to changing environments and scale up at a pace that would not be possible with other forms of investment. This capital can be used for a range of purposes, as long as it sticks to what was set out in the initial agreement.

Strategic expertise

Bringing in people with expertise in specific areas is another benefit. Many private equity funds specialise in certain sectors, such as technology, and can provide expert advice on the best way forward for the company. They also offer access to large networks of potential partners or new customers. This can help firms open doors and connect with new opportunities.

For growing firms, private equity offers the opportunity to strengthen their management and decision-making teams. A new presence in the boardroom can also see the firm from a different perspective than founders. This can make it easier to spot gaps in the market or areas that are not currently being fully exploited.

Long-term potential growth

Private equity is not a long-term source of funding, but it can give businesses more security and opportunities for growth. While its nature means that private equity investors will seek an exit strategy eventually, many deals have medium-term commitments that ensure investors cannot withdraw early. This can help firms set out a clear plan for the next five to ten years with milestones for growth.

There will always be potential downsides to any source of investment that you need to bear in mind. Understanding what these risks are and whether or not they outweigh the benefits should be a key part of decision-making when choosing funding options. While no two companies will have the exact same issues, there are a few common dangers that every firm will need to think about, including liquidity risk, market risk and operational risk.

High risks of capital

Private equity funds often accept a high-risk, high-reward strategy when it comes to targeting businesses for investments and acquisitions. This is especially true for those that focus on early-stage growth. To mitigate these risks, founders should be able to present clear growth plans that demonstrate how the business will generate value in the medium and long term.

Loss of control

Many founders see handing over control of the business they've built from scratch as the biggest mark against private equity. Common concerns are that investors will push the company in a direction that takes it away from its original principles or aims. This could change the nature of the enterprise and leave entrepreneurs without a say. That's why choosing the right private equity partner matters for founders. It's important to work with people with shared values and a commitment to the future of the business.

Risk of investment failure

There are several reasons why a private equity venture may fail to deliver the returns its investors expect. This impacts business founders as well as private equity funds. If firms are handing over large parts of their operations - or even controlling stakes - they expect positive returns just as much as investors.

Issues could be related to wider economic turbulence or poor performance within the business. Challenges could include:

• Shifting market conditions
• Inaccurate valuation of the business
• Emergence of more advanced competitors
• Changing customer demands or industry regulations
• Culture clashes between investors and employees

Effective due diligence on both sides can help to mitigate many of these risks and ensure that private equity is right for both parties.

Private equity can be an effective way to secure the funding you need to take your business to the next level. But it's not a suitable option for all companies. If you're considering this route, you should ask a few key questions before proceeding. For example:

• What level of operational control will I have to give up?
• Are there alternative sources of funding available?
• What is the track record of a potential private equity partner?
• What industry expertise or connections will they be able to provide?
• What will the eventual divestment strategy look like?

Private equity brings more to a company than capital. However, if you consider the trade-offs in terms of control or risk too much, other options may be a better fit. Check out our Insights Hub for more ideas on how innovative companies can scale up for the future.