Glossary
Private equity may be viewed from two standpoints: as an asset class in fund managers' portfolios (as in the case of pension fund managers) or as a way of investing in companies.
As an asset class, private equity (sometimes referred to as private placement) is part of the broader class of alternative investments that also include real estate, hedge funds, infrastructure and similar assets. This class stands out in particular from publicly traded stocks and bonds.
As an investment activity, private equity may be defined as the act of making equity or quasi-equity investments in companies through a negotiated process. Most private equity investments are made in private companies, though some consist of negotiated investments in publicly traded companies. Private equity generally goes together with an active investment strategy and relies on specialized investment teams that bring a constructive contribution to the companies in which investments are made.
The terminology used to designate the various components of private equity can easily lead to confusion since the same set of terms is usually segmented on the basis of three different perspectives:
Company development stages or types of transaction
Depending on a company's development stage, we refer either to (i) startup capital / early stage capital or venture capital, or (ii) growth equity. A company's various development stages consist of:
- Early stage (premiers stades, démarrage)
1.1 Seed (amorçage, prédémarrage)
- The initial phase in the creation of a company. In the innovation chain, this stage follows the filing of a patent, if applicable, and also comes after the concept validation stage. Financing is aimed at research, assessment and development of an initial concept. This phase mainly involves companies with a high technological or scientific content.
1.2 Startup (démarrage)
- The company is just getting started. For companies with high technological or scientific content, financing is often aimed at product development or at the validation of a technology. For companies with medium or low technology content or operating in more traditional sectors, financing is often intended to kick off commercial or industrial activities.
1.3 Other early stage (post-démarrage)
- The company has already completed the development of a product but is not generating significant profits. Normally, for companies with high technological or scientific content, the commercial risk remains very relevant despite the technological risk being significantly reduced. At this stage, most biotech companies haven't begun conducting clinical trials. Companies in medium or low technology areas or in more traditional sectors are generally at the stage of developing the commercial or industrial activity that will allow their company to achieve sustained earnings on a going-forward basis.
- Expansion, growth (développement, croissance)
- The company generally has a viable product, a developed market, significant clients and sustained revenue growth, and it has reached its break-even point, producing not only profits but also positive cash flows. Financing is often aimed at increasing production capacity, expanding the sales force and developing new products, services or markets, as well as financing acquisitions and/or increasing working capital.
- Other transaction types
3.1 Buyout (rachat)
- Acquisition of a company or a controlling stake in a company by private equity investors, executives of the target company and/or a new team as part of a financing package which will have a fairly high debt-component (which is why it may be referred to as an LBO, (short for leveraged buyout)) with repayment relying in part on future cash flows of the company.
There are several possible contexts:
- MBO (management buyout): buyout of a company by its management team (one or more executives, who may be non-shareholders or minority owners);
- MBI (management buy-in): buyout of a company with one or more outside takeover specialists;
- BIMBO (buy-in management buyout): buyout of a company with an outside takeover specialist in association with the company executives.
3.2 Turnaround (redressement d'entreprise)
- Capital invested in a company that has had financial difficulties and for which measures providing for a return to profitability have been identified and are to be implemented.
3.3 Secondary purchases (achats de positions minoritaires)
- Purchase of shares held by one or more minority shareholders.
According to many investors and asset managers (such as pension funds), private equity is subdivided into three asset classes usually managed by different types of investors or funds: venture capital, expansion / buyout, and mezzanine.
Venture capital (capital de risque; AFIC: capital risque)
- A specialized form of private equity characterized mainly by investments in companies in early stages of development. The investment generally carries high or very high risk. Venture capital funds normally target, in particular, companies in early stages of development in sectors with a high technological or scientific content, these being companies with high growth potential.
Expansion / buyout (développement / rachat)
- A specialized form of private equity investment focused on companies that are at the expansion or growth stage and which is not a mezzanine investment. Such investments are not restricted to certain sectors, although some growth equity funds focus their investments on particular industries. This covers investments aimed at acquiring majority ownership (buyouts, in reality) as well as those aimed at acquiring minority ownership to help the company grow or to finance a buyout or turnaround. Buyout funds (in the meaning of the asset class) often are active in both majority and minority transactions, depending on the economic environment (e.g., access to bank debt). They may also become involved from an early stage after startup, depending on the exit period sought for the investment (position in the investment cycle).
The definition of the term "buyout" therefore varies in accordance with the context in which it is used, making reference to either an asset class or to a transaction type depending on the circumstances.
Mezzanine 2
- A specialized form of private equity characterized mainly by the use of debt, with repayment of such debt subordinated to the reimbursement of senior debt or preferred shares. It generally contains an option to have a stake in the company's equity (warrants) which is triggered upon the occurrence of certain events. This type of private equity investment is usually targeted towards companies that are at the expansion or growth stage.
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2 Certain types of investors that are active in private equity also invest in the form of debt, with or without obtaining a security on the assets of the borrowing company and with repayment by the company subordinated to reimbursement of senior debt with no options or rights to have access to the company's equity. The interest rates that apply in such cases are generally higher. Since no type of investor or fund specializes in this type of investment, it is not recognized as an asset class. Types of investors - Canadian and Québec particularities
The dominant model in venture capital in the United States is the private independent fund (with equity coming from several sources and with no investor holding a majority of the equity), most often structured as limited partnerships. These funds generally specialize either in venture capital, in buyouts (in the broader sense of the term) or in mezzanine financing, with these three types of activities requiring different manager profiles and skill sets.
The situation is different in Québec and Canada as a whole. Private independent funds account for only part of the sums invested. Alongside private independent funds, several types of investors play a major role, notably:
- Government funds
Government agencies or state-owned corporations.
- Institutional investors
Funds managed by major financial institutions: banks, insurance companies or pension funds.
- Growth equity funds (tax-advantaged funds)
Funds that collect capital from individual investors who receive a tax incentive for investing in these funds. There are three such funds in Québec: the Fonds de solidarité des travailleurs du Québec (FTQ), Fondaction CSN and Capital régional et coopératif Desjardins.
These investors often have activities that overlap in the three asset classes (venture capital, buyouts and mezzanine). This applies in particular to the tax-advantaged funds, which play a very important role in Québec. They are involved in all three asset classes:
- Venture capital, both in companies with high technological or scientific content and in those operating in other sectors;
- Buyouts, mainly in the form of growth or buyout equity (minority transactions to finance buyouts) and, in some cases, in the form of buyout capital (majority transactions);
- Mezzanine financing (subordinated debt, generally unsecured, with or without options on equity of the company).
Also, as in the United States, angel investors play a significant role in the private equity market in Québec.
The
summary diagram sums up the overlay in terms of development stage, type of transaction, asset class and type of investor.
Classification for statistical purposes
The Canadian database on the private equity industry is maintained by Thomson Reuters. It covers two aspects, namely investments and fund raising. A report is also produced twice a year, in collaboration with CVCA, on the returns from Canadian private equity funds.
Thomson Reuters classifies the following investments as venture capital investments:
- Early stage investments made by any type of fund are usually classified as venture capital investments with the exception of investments in the mining, oil and gas industry as well as investments in certain other traditional sectors which are usually conducted by funds specializing in these respective areas and classified as growth equity investments.
- Investments made by venture capital funds are usually classified as venture capital investments regardless of a company's stage of development. Even if a company is at the expansion or growth stage, investments that follow up on initial venture capital investments are also classified as venture capital investments until there the occurrence of an exit event, an acquisition or a significant investment by one or more non-venture capital funds.
- Later investments by institutional investors or growth equity funds (including tax-advantaged funds) are usually classified as buyout or mezzanine investments unless they are follow-ups to venture capital investments or are made as co-investments with venture capital funds.
Data on the two other asset classes are significantly less comprehensive than those for venture capital.
For statistical purposes, the following investments are considered as growth / buyout equity investments:
- All buyout funds, except for cases involving investments in early-stage development in areas of innovation or co-investments with venture capital funds;
- For other types of investors, this category covers only investments that are not classified as venture capital or mezzanine financing.
As regards mezzanine financing, the following are included for statistical purposes:
- All investments by mezzanine funds;
- For other types of investors, all transactions conducted in the form of subordinated debt, whether secured or not and with or without options on equity of the company.
*Some French terms are shown in parentheses. Where there are differences in terminology between Réseau Capital and the French venture capital association AFIC (Association française d'investissement en capital), this is noted.
