WORLD ACADEMY OF INFORMATICS AND MANAGEMENT SCIENCES
ISSN : 2278-1315
that the previous company management had been unable to
funding to expand its operations or investments, or some other
do. A strategy of private equity funds might be to look for
reason.
target companies that they consider under-valued, with the
In other words, securitization is the procedure whereby an
intention of improving their operations and creating extra
issuer designs a financial instrument by merging various
value.
financial assets and then markets tiers of the repackaged
Private equity is an alternative investment class and consists
instruments to investors. This process can encompass any type
of capital that is not listed on a public exchange. Private
of financial asset and promotes liquidity in the marketplace.
equity is composed of funds and investors that directly
The process of securitization creates liquidity by enabling
invest in private companies, or that engage in buyouts of
smaller investors to purchase shares in a large asset pool. It
public companies, resulting in the delisting of public equity.
can involve the pooling of contractual debts such as auto loans
Institutional and retail investors provide the capital for
and credit card debt obligations, or any assets that generate
private equity, and the capital can be utilized to fund new
receivables.
technology, make acquisitions, expand working capital, and
Banks hold many assets which give them access to future cash
to bolster and solidify a balance sheet.
flows (e.g. mortgages, credit cards, loans etc.). This involves
Private equity investment comes primarily from institutional
the transfer of the interest bearing assets to a ‘special purpose
investors and accredited investors, who can dedicate
vehicles’ (SPVs). The SPV effectively purchases a bank’s
substantial sums of money for extended time periods. In
mortgage book for cash which is raised through the issue of
most cases, considerably long holding periods are often
bonds backed by the income stream flowing from the
required for private equity investments in order to ensure a
borrowers. This results in the conversion of future cash
turnaround for distressed companies or to enable liquidity
receipts into cash today.
events such as an initial public offering (IPO) or a sale to a
Mortgage Backed Securities (MBS) are a perfect example of
public company.
securitization, which are securities backed by mortgage
Private equity offers several advantages to companies and
receivables. The principal and interest on the debt underlying
startups. It is favored by companies because it allows them
the security are paid back to the various investors regularly.
access to liquidity as an alternative to conventional financial
By combining mortgages into one large pool, the issuer can
mechanisms, such as high interest bank loans or listing on
divide the pool into smaller pieces based on each mortgage’s
public markets. Certain forms of private equity, such as
inherent risk of default and then sell those smaller pieces to
venture capital, also finance ideas and early stage
investors. With a mortgage-backed security, individual retail
companies. In case of companies that are de-listed, private
investors can purchase portions of a mortgages as a type of
equity financing can help such companies attempt
bond. Without the securitization of mortgages, retail investors
unorthodox growth strategies away from the glare of public
may not be able to afford to buy into a large pool of
markets. Otherwise, the pressure of quarterly earnings
mortgages.
dramatically reduces the timeframe available to senior
In Nigeria, Mortgage Backed Securities are being promoted
management with new ways to cut losses or make money.
by the Securities and Exchange Commission in view of their
potential to address the huge housing deficit.
Features of Private Equity Funding
b. Private equity is equity in operating companies that
Features of Asset securitization and sale
are not publicly traded on a stock exchange.
a. Securitization is the process of conversion of existing
c. Private equity as a source of finance includes
assets or future cash flows into marketable securities.
venture capital and private equity funds.
b. Typically the following occur simultaneously:
d. A private equity fund looks to take a reasonably
i.
Company A sets up Company B (described
large stake in mature businesses.
as a special purpose vehicle or SPV) and
e. In a typical leveraged buyout transaction, the
transfers an asset to it (or rights to future
private equity firm buys majority control of an
cash flows).
existing or mature firm and tries to enhance value
ii.
Company B issues securities to investors for
by eliminating inefficiencies or driving growth.
cash. These investors are then entitled to the
f. Their view is to realize the investment possibly by
benefits that will accrue from the asset.
breaking the business into smaller parts.
iii.
The cash raised by Company B is then paid
to Company A
When Private Equity Funding is Appropriate
a. If used as a source of funding a private equity fund
c. In substance this is like Company A raising cash and
will take a large stake (30% is typical) and appoint
using the asset as security.
directors.
d. Accounting rules might require Company A to
b. It is a method for a private company to raise equity
consolidate Company B even though it might have
finance where it is not allowed to do so from the
no ownership interest in it.
market.
e. Conversion of existing assets into marketable
securities is known as asset backed securitization and
Financing by Asset securitization and sale
Securitization is the process by which a company packages
the conversion of future cash flows into marketable
its illiquid assets as a security. For example, when a
securities is known as future-flows securitization.
company makes an initial public offering, it effectively
f. Used extensively in the financial services industry.
packages the company’s ownership into a certain number of
When Asset securitization and sale is Appropriate
stock certificates. Securities are backed by an asset, such as
i.
Allows the conversion of assets which are not
equity, or debt, such as a portion of a mortgage.
marketable into marketable ones.
Securitization allows a company access to greater
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