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Private Equity
The
Federal Deposit Insurance Corporation (FDIC)
preserves and
promotes public confidence in the U.S. financial system by
insuring deposits in banks and thrift institutions for at least
$100,000; by identifying, monitoring and addressing risks to the
deposit insurance funds; and by limiting the effect on the economy
and the financial system when a bank or thrift institution fails. An independent agency of the federal government, the FDIC was created in 1933 in response to the thousands of bank failures that occurred in the 1920s and early 1930s. Since the start of FDIC insurance on January 1, 1934, no depositor has lost a single cent of insured funds as a result of a failure. According to the Federal Deposit Insurance Corporation (FDIC), the private equity market in the United States has evolved over the years, with financial institution involvement only becoming significant in the 1960s and 1970s. Where these funds are invested also has changed over time. Currently, most private equity funding is used to fund start-up or early-stage companies or to bring large public companies private. Private equity investments can be made through limited partnerships or they can be direct investments. Subsidiaries of banking organizations are probably the largest direct investors in this market. Evolution of the Private Equity Market Given its history, merchant banking is often thought of as a European, and especially British, financial specialty, and British institutions continue to maintain a major presence in this area. Since the 1800s and even earlier, however, U.S. firms (such as J.P. Morgan) also have been active in merchant banking. However, although both investment banks and commercial banks, as well as other types of businesses, have been authorized to engage in private equity investment in the United States, financial institutions have not been major providers of private equity. Until the 1950s, U.S. investors in private equity were primarily wealthy individuals and families. In the 1960s and 1970s, corporations and financial institutions joined them in this type of investment. (In the 1960s, commercial banks were the major providers of one kind of private equity investing, venture-capital financing.) Through the late 1970s, wealthy families, industrial corporations, and financial institutions, for the most part investing directly in the issuing firms, constituted the bulk of private equity investors. In the late 1970s, changes in the Employee Retirement Income Security Act (ERISA) regulations, in tax laws, and in securities laws brought new investors into private equity. In particular, the Department of Labor's revised interpretation of the "prudent man rule" spurred pension fund investment in private equity capital. Currently, the major investors in private equity in the United States are pension funds, endowments and foundations, corporations, and wealthy investors; financial institutions-both commercial banks and investment banks-represent approximately 20 percent of total private equity capital, divided approximately equally between the two. The U.S. Department of the Treasury (Treasury) estimates that at year-end 1999, commercial banks accounted for approximately $35 billion to $40 billion, and investment banks for approximately another $40 billion, of the $400 billion total investment in the private equity market. At $400 billion as of year-end 1999, the private equity market is approximately one-quarter the size of the commercial and industrial bank-loan market and the commercial-paper market. In recent years, funds raised through private equity have approximately equaled and sometimes exceeded funds raised through initial public offerings and public high-yield corporate bond issuance. The market also has grown dramatically in recent years, increasing from approximately $4.7 billion in 1980 to its 1999 figure. Despite this tremendous growth, the private equity market is extremely small compared with the public equity market, which was approximately $17 trillion at year-end 1999. Typical Uses of Private Equity Private equity financing is an alternative to raising public equity, issuing public debt, or arranging a private placement of debt or bank loan. The reasons companies seek private equity financing are varied. For example, other forms of financing may be unavailable or too expensive because the company's track record is either nonexistent or poor (that is, the company is in financial distress). Or a private company may want to expand or change its ownership but not go public. Or a firm may not want to take on the fixed cost of debt financing. Public firms may seek private equity financing when their capital needs are very limited and do not warrant the expense, time, and regulatory paperwork required for a public issue. They also may seek private equity to keep a planned acquisition confidential or to avoid other public disclosures. They may use the private equity market because the public market for new issues in general is bad or because the public equity market is temporarily unimpressed with their industry's prospects. Finally, very often in recent years, managements of large public firms have felt their firms will benefit from a change in capital structure and ownership and will choose to go private by means of a leveraged buyout (LBO). Although companies seek private equity for all these reasons, most private equity funding has been used for one of two purposes: to fund start-up or early-stage companies (venture capital) or to bring large public companies private in LBOs. Of the $400 billion in outstanding private equity investment at year-end 1999, venture-capital investments accounted for approximately $125 billion and nonventure-capital investments for approximately $275 billion. LBOs were by far the most common use of nonventure-capital private equity. To learn more: www.fdic.gov -------------------------------------------------------------------------------------------------------------------------------------------- Best Alternative Investment Books ---------------------------------------------------------------------------------------------------------- |
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