Investments in Private Capital: Equity and Debt

Private equity and private debt finance companies outside public markets, from start-ups to large take-privates, and together form the largest part of most institutions' alternative portfolios. This module explains the main private equity strategies, how buyouts create (and destroy) equity value, the forms and risks of private debt, and what private capital really adds to a diversified portfolio once smoothed valuations are seen for what they are.

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What you will learn

1. Explain the main private equity strategies, leveraged buyouts, venture capital and growth equity, and the stages of company development each one finances.

LBO: control of a mature, cash-generative company financed mostly with debt; MBO uses existing managers, MBI brings in new ones.
VC stages: pre-seed (angel), seed, early stage, later stage, mezzanine (pre-IPO).
VC returns are highly skewed: a few winners pay for many failures, so diversification is essential.
Growth equity: minority stakes in established, growing companies with little leverage.
Post-money valuation = pre-money valuation + new investment; new rounds dilute earlier investors.

2. Explain how leveraged buyouts create value and how private equity investments are exited, and calculate the equity return on a simple buyout.

Value creation: EBITDA growth, multiple expansion and debt paydown, all amplified by leverage.
Exit equity = exit EV - net debt at exit; MOIC = exit equity / entry equity.
Leverage magnifies losses too: heavy debt service leaves little room for investment or setbacks.
Exit routes: trade sale, secondary sale, IPO, recapitalization, write-off.
Active governance and management equity align incentives.

3. Describe the main forms of private debt and compare their risk and return characteristics.

Direct lending: senior secured, floating-rate loans to mid-sized, often sponsor-backed companies; unitranche blends senior and junior debt.
Mezzanine: subordinated, higher coupon, often PIK interest and warrants.
Venture debt finances start-ups with less dilution; distressed debt buys troubled debt at deep discounts.
Risk and return rise from senior direct lending to unitranche, mezzanine and distressed debt.
Expected return is approximately all-in yield minus expected loss (PD x LGD).

4. Describe the risk, return and diversification characteristics of private equity and private debt and their role in a portfolio.

Private equity return = public equity exposure + illiquidity premium + manager value added.
Manager dispersion is far wider than in public markets, so manager selection is critical.
Smoothed NAVs understate volatility and correlation; buyouts behave like leveraged small and mid caps.
Commit across vintage years as well as managers, strategies and regions.
Private debt: lower volatility, floating-rate income, but credit-cycle exposure.

Module at a glance

LBOs buy control of mature, cash-generative companies with mostly debt; VC funds young firms in stages; growth equity takes minority stakes.
Post-money = pre-money + new investment; later rounds dilute earlier investors.
Buyout equity gains come from EBITDA growth, multiple expansion and debt paydown, all magnified by leverage.
Exit equity = exit EV - net debt at exit; exits are trade sales, secondary sales, IPOs, recaps or write-offs.
Private debt ranges from senior direct lending through unitranche and mezzanine to distressed debt.
Expected loan return is roughly all-in yield minus PD x LGD.
Smoothed NAVs understate private capital risk; diversify across vintages and managers.

This free module has 4 lessons, 12 practice questions with full explanations.

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