Once a company goes public and the price of its shares go up I guess some investment firms can make money that way. But how do investment firms that invest in non-public companies (e.g. small startups) make money? Do they just keep on investing until the company goes public and they can reap profits (through stock prices etc.)?
In: Economics
Venture Capital and Private Equity firms hold shares or percentage of ownership in companies. They hope to help the business grow so that it can either go public, in which case their private shares become public shares they can sell for profit. Or the business gets acquired, resulting in them getting paid out in cash and/or stock of the acquiring company.
There’s only a couple of ways that you can make money off a private company *if you’re investing (buying shares)*:
– **Exit opportunities**: You invest (buy shares) in the company when it’s small… after it grows… you either wait for it to go public (IPO) or for another company to want to acquire it (acquisition). Sometimes, other investors might buy your shares off you or the business might buy them back, but because it’s a private company… it’s a lot harder to do compared to public companies.
– **Dividends**: Most start-ups won’t pay these. It’s where they split the *profits* (may just be out of cash reserves) between the shareholders (if you have more shares you get more amount). As mentioned, most start-ups who want investment won’t start giving cash back to investors as it’s draining money and could stunt their growth.
This is called venture capital and if early enough, angel investment. Two main ways.
1) Many small companies are acquired by larger companies.
2) IPO. The IPO price typically returns many multiples of the amount invested.
In many tech companies, option 1 is more likely than option 2. To spread the risk, venture capitalists usually invest in multiple firms, relying on the rare successes to pay back for the more common failures and still leave significant profit.
Private companies have stock too, which is held by the owners. So, VC firms / angel investors will take a percentage of ownership, proportionate to the amount of investment & risk. As the company makes money so do the investment firms.
A company produces value, for example if that start up invents a new product, popular software etc. The company gets more value = shares going up.
Basically you can think of it as a pie. The pie gets cut into 10 pieces and being worth (at the time it was cut) $1, each piece is now $0.10 worth. However, a new ingredient gets added onto the pie, now each piece is worth $0.20 and so on.
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