Disadvantages of Private Equity
Higher Rate of Return
- Private equity investors typically expect a higher rate of return than a commercial lender. As most businesses interested in a private equity investment may not qualify for a commercial loan, the business may not have many options to negotiate a lower rate of return. Though the expected rate of return will vary, 35 percent is a typical rate of return that a private equity investor expects. This is much higher than the interest charged by most loans from commercial lenders.
- Private equity investors generally take an ownership stake in a company. Unlike commercial lenders who lend money and simply expect the business to make payments on the loan, private equity investors will want a percentage of the company. As part of ownership, the private equity investor may also place its own people into management or other executive level positions within the company. Though these people may become an asset to the company, the original owner will no longer have complete control of the company. Private equity investors generally will only want ownership for a period of years until the business owner can buy out their interest in the company.
- Another disadvantage of using private equity as a source of revenue to expand a business is that it may take some time for the private equity investor to make a decision. Unlike commercial lenders that have a set formula used to determine whether or not to make a loan, a private equity investor, or group of investors, looks at each investment opportunity on a case-by-case basis. Since a private equity investor may be considering a number of investments, but only has the funding for one or two of the investments, a business anticipating a decision may have to wait until the investor reviews all of the businesses under consideration.
- As a private equity investor will likely assume ownership of part of a business, there will be extensive legal documentation needed to complete the deal. This documentation will generate considerable legal expenses as well as lengthening the time needed to complete the deal. Some private equity investments may also require specific legal filings with government regulators that will require the assistance of an attorney and an accountant experienced in reporting complicated business deals.