How to raise capital, privately.

• Author: Hofmann, Donald J., Jr.
• Position: State-of-the-Art Treasury Management

As many financial executives look to the traditional public places for capital transfusions, private equity investing may be quietly revolutionizing the markets.

A QUIET REVOLUtion has changed forever the way American companies gain access to the capital necessary to grow and create jobs.

Private equity investment capital is now available to small and large companies in nearly every industry. The growth of the private equity industry in the past 10 years has been astounding, as the total funds committed have grown from $5.6 billion in 1982 to $95.3 billion in 1992, according to the Private Equity Analyst, a leading industry publication. Financial executives in public and private companies should consider using private equity as they attempt to optimize the capital structures of their companies.

Private equity comes in many shapes and sizes, roughly corresponding with a company's position in the corporate life cycle. The three most common types of private equity are venture capital, strategic block investments and leveraged buyouts.

Venture capital, provided at the formation of a company or during a period of rapid growth, is the riskiest form of private equity, due to the high failure rates of new companies. But it provides the highest return to investors. Among the most successful venture capital-backed firms in the U.S. are Apple Computer, Federal Express and Office Depot.

A strategic block investment usually takes the form of a large minority position, typically in a public company. Its popularity has grown considerably in the past five years, as U.S. companies have wanted to concentrate large blocks of stock in friendly hands. Examples of strategic block investments include Warren Buffett's purchase of a stake in Salomon Brothers and a $300-million investment by Corporate Partners in Polaroid to help the company avoid a hostile takeover.

Leveraged buyouts, by far the largest category of private equity, involve the purchase of a company or division, utilizing the assets and cash flow of the acquired entity to borrow heavily to finance the purchase. Leveraged buyouts range in value from a few million dollars to multibillion-dollar transactions. Many leveraged buyouts have involved household names, such as the acquisition of RJR Nabisco by Kohlberg Kravis Roberts, the purchase of Gibson Greeting Cards by William E. Simon and Forstmann Little's acquisition of Dr. Pepper.

American companies, now more than ever, must raise capital to grow their businesses and remain competitive in a global economy. This requires huge capital investments to improve manufacturing productivity, provide for sophisticated information technology and fund overseas expansions. Today's sophisticated financial executive may believe there are many alternatives to raising this capital but may not recognize the volatility inherent in the most common forms of corporate financing.

ARE YOU LIMITING YOURSELF?

The traditional methods of funding capital requirements are through internally generated cash flow, supplier credit, bank borrowing and issuance of public debt and equity. Private equity investments have...