Public equity vs. private equity

They are public and private equities, the ones earlier discussed can be grouped under public equities. Private equities on the other hand as the name implies are private. Private equity are illiquid because shares cannot be easily traded. Share price is negotiated between the firm and its investors, and unlike public equities they are no requirements of disclosures by the government or exchange commission.

Private equity are usually targeted to high net worth individuals and institutional investors, and they have a greater ability to focus on long term prospects because there is no public pressure for short term results. There are three main types of private equity , they are the venture capital, leveraged buyout and private investments in public equity.

Venture capital refers to capital provided to firms early in their life cycles to fund their development and growth. In venture capital financing when you start growing the business, you fund research and development, the highest costs would be incurred at this stage. Proper due diligence should be undertaken at this stage to prevent loss of investments.

In the famous words of Warren Buffet, it is advisable that you do not invest in a business you cannot understand. The expansion stage of a venture capital is undertaken when the business as grown and needs to expand production, varieties of products or any other resource or output that requires expansion. Private equity investors can invest in such companies help it increase its operations across the countries, continents or even the world.

Private equity investors can then get a return on their investment from an already established business. There may be no need for research and development at this stage because the company already has a successful business model.

In a leveraged buy-out, investors purchase a firm’s equity using debt financing. Firms in LBO usually have cash flow that is adequate to service the issued debt or have undervalued assets that can be sold to pay down the debt over time.

Private investments in public equity

In this a company that needs cash quickly may sell a portion of its equity to private equity investors, and can sell it at a sizable discount to its market price to attract investors.
There may be restrictions in the movement of capital from one country to another. When capital flows freely across borders, they are said to be integrated. Countries that want to support indigenous ownership and do not want foreigners control the shares, might place restrictions on foreign ownership of domestic stock.

To foster economic growth, countries drop foreign capital restrictions. Studies have shown that reducing capital barriers improve equity market performance. Also foreign investments bring publicity to domestic companies, and increases transparency due to stricter requirements on disclosure.
They are a number of ways a foreign investor can use to invest in company outside his country. They include:

a) Direct investing: Here the foreign investor invests in a foreign company by buying her securities in a foreign market.

b) Depository receipts: They represent ownership in a foreign firm and are traded in the markets of other countries in the markets of other countries in local market currencies. Depository receipts are sold by banks in the local market to represent a foreign company’s publicly traded securities. It is an investment vehicle which can be used by individual or corporate investors who cannot invest directly in the foreign company either due to capital restrictions or minimum investment requirements or other types of restrictions.

The depository bank acts as a custodian and manages dividend, stock splits and other events. Depository may be sponsored or unsponsored. It depends on whether the company that issue the shares enters into an agreement with the custodian bank that issues the depository receipt locally.

If the firm is involved in the issue, it is a sponsored depository receipt, and if the firm is not, it is an unsponsored depository receipt. One advantage of a sponsored depository receipt over an unsponsored depository receipt is that the sponsored depository receipt provides investors voting rights while an unsponsored depository receipt’s right is taking by the depository bank. Two forms of depository receipts are the global depository receipt (GDR) and the American depository receipt (ADR). An ADR as the name implies is listed and traded on exchange basis in the united states, while a GDR is usually traded in established non us markets like London and Luxembourg.
Although not listed in the us, GDR’s are usually denominated in US dollars.

c) Global Registered Shares: They are traded in different currencies or stock exchanges around the world. In the USA for example, as opposed to American Depository receipts, foreign companies can list their ordinary shares on the NYSE with the aid of a global registered share. The good thing about a global registered share is that it provides shareholders across the globe with equal corporate rights.

 

Recommended Readings 

Alternative Investments: CAIA Level I (Wiley Finance)

Frank Fabozzi., Financial management and analysis