A buyout fund is a means by which investors can purchase equity in a private company that is not listed on a stock exchange. Such deals often involve both refinancing of a company and a significant structural change. In many cases, a buyout fund will make use of leverage, meaning the main organization behind the buyout does not provide all the financing.
The key to a buyout fund is that usually the entire company will be bought by the investors behind the fund. The idea is that the money used for the purchase will help finance future business activities. This set up differs from venture capital, which is commonly used for relatively new and small companies where the current owners need cash but do not want to give up control.
One of the most common uses of a buyout fund is in a leverage buyout. This is where one company seeks to take over another company, but does not want to pay the entire purchase price. To resolve this, the company sets up a private equity fund, which is a legal entity in itself. Investors are invited to buy shares in the fund, and the resulting cash is used to finance the purchase of the target company. The repayment and interest to the investors come from the company's future income.
There are benefits and drawbacks of this type of buyout fund for investors. The main advantage is that the financial return comes quicker than with other types of investment and is more stable and predictable. The main drawback is that the liability of the company heading the takeover is limited. If it fails to repay the investors, they will usually not be able to make a claim on its other assets.
Where a company needs financing but does not want to sell out completely, it may offer mezzanine debt to a buyout fund. This is a type of debt that has a particularly low claim on company assets; in the event the company is liquidated, mezzanine debt holders will be at the back of the line for a share of assets, ahead only of ordinary shareholders. To compensate for this, the rate of return offered on mezzanine debt is a lot higher than with other types of debt products.