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Minority Investment

Guide to Understanding the Minority Investment Structure

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Minority Investment

Minority Investment Structure in Private Equity

A minority interest refers to investments with less than 50% equity ownership.

In the private equity industry, firms specializing in minority investments obtain a non-controlling stake in a company’s equity in exchange for capital.

The objective of minority investments is to provide capital to a company already exhibiting significant growth and trending in an upward trajectory.

The two types of firms that most commonly engage in minority investments within the private markets are the following:

  1. Venture Capital (VC) → In venture capital, the investments are made into smaller-sized, high-growth companies attempting to disrupt industries (and thus, the risk is substantially greater).
  2. Growth Equity → In comparison, the funding provided by growth equity firms is intended to support the management team’s existing plans for growth, i.e. continue the positive momentum.

If an institutional firm makes a minority investment in a company’s equity, it owns a significant percentage of the total equity interest, yet its stake is non-controlling.

While there can be exceptions, such as with highly-regarded VC firms – most firms that make minority stake investments, especially those that invest in the later stages of a company’s lifecycle – tend not to be influential in the company’s decisions and strategies.

Minority Investment vs. Majority Investment

How Do Minority Investments Work?

Generally, minority investments consist of around 10% and 30% of the company’s total equity. In contrast, a majority investment implies the firm’s equity ownership exceeds 50%.

  • Minority Interest → <50%
  • Majority Interest → >50%

While the investments made by venture capital and growth equity firms are nearly always structured as minority investments, traditional private equity firms (LBOs) almost always make majority investments, barring unusual circumstances.

The trade-off here is that minority investors hold less influence over the company’s decisions and strategy, but controlling the company’s decisions is rarely the firm’s objective, anyway. Instead, the firm recognizes the company’s outlook is promising and seeks to participate in the upside potential (and is thus “along for the ride”), even if that means their investment strategy is relatively “hands-off”.

Advantages and Disadvantages of Minority Investments

Advantages Disadvantages
  • High Entry Valuation (i.e. Positive Outlook and Strong Historical Financial Performance)
  • Majority Control Retained by Founders
  • Established Business Model and Validated Product-Market Fit
  • Onerous Terms and Unfavorable Conditions
  • Growth Capital to Fund Existing Expansion Plans
  • Limited Alignment with Founders (and Existing Investors)
  • Generally, Passive “Hand-Off” Capital Provider
  • Lack of Operational Value-Add Opportunities

Minority Buyout vs. Minority Growth Equity

  • Minority Buyout: A minority buyout is far less common than a majority buyout, as most private equity firms seek a controlling stake over the post-LBO target given the amount of debt placed on the balance sheet. In a minority equity buyout, the management team – usually the founder(s) – undergoes a liquidity event with the opportunity to “take some chips off the table” while still retaining majority control over the company. Since the management team plans to continue running the company for the foreseeable future, the firm they decide to partner with is a strategic partner rather than a mere capital provider. Hence, the value-add capabilities are just as important to the founders as the valuation at which the capital was invested.
  • Minority Growth Equity: In contrast, the capital received from a minority growth equity investment mostly flows straight to the company’s balance sheet, instead representing a liquidity event for the management team. The newly-raised capital funds future growth plans, expansion strategies, and acquisitions. While management can still benefit from realizing monetary gains post-investment, the priority is to grow the company using the growth capital.

Minority Investment Example

One recent example of a minority investment – or more specifically – a struggling public company attempting to raise capital, is Peloton (NASDAQ: PTON), the fitness equipment maker that saw its stock price reach record highs during the pandemic.

Peloton is seeking potential investors, such as strategic buyers and private equity firms, to acquire a 15% to 20% stake as it attempts a major turnaround.

But as mentioned earlier, most firms that make minority stake investments have a “buy high, sell even higher” approach to investing, so it is understandable why these firms are not jumping at the opportunity to provide capital to Peloton.

Hence, Peloton has faced difficulty in raising capital from institutional investors as it attempts a turnaround after its stock price plummeted once pandemic-related tailwinds faded.

Peloton Minority Investment Example

“Peloton Seeks Minority Investment to Shore Up Business” (Source: WSJ)

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