Final answer:
Private equity firms invest capital from individuals and institutions into early-stage companies, where venture capitalists have an edge in information over potential bondholders. Small firms raise money from private investors to avoid the complexities of an IPO. However, as a company grows, its information becomes widely available, attracting other investors like bondholders and shareholders.
Step-by-step explanation:
Private equity firms manage investments from individuals and institutional investors by channelling their capital into opportunities that offer the potential for significant returns. These firms typically invest in early-stage corporate finance, among other stages, to foster growth in smaller companies. Very small companies often opt to raise money from private investors rather than an initial public offering (IPO) due to the high costs and rigorous regulatory requirements involved in going public. For small, young companies, an IPO might be preferred over borrowing from a bank or issuing bonds as it provides significant capital that doesn't require immediate repayments and offers liquidity to early investors without incurring debt.
A venture capitalist often has better information about whether a small firm is likely to earn profits compared to a potential bondholder. Venture capitalists typically have close relationships with the companies they invest in and an in-depth understanding of their business models and potential, thus providing them with a more informed position to predict profitability. On the other hand, as a firm grows and becomes more established, the need for personal knowledge of the managers lessens, as financial information about the company's performance becomes more publicly available. Subsequently, a wider array of investors, including bondholders and shareholders, may be willing to provide financial capital to the firm.