What are private equity firms?
In: 4
*Equity* is ownership, or partial ownership, in this case of a company. A share of stock is a form of equity, for example: it represents partial ownership of the company that issued that stock. If equity in a company is traded publicly on a stock market, we say that that is a *public company*.
Private equity, then, is equity in a company that is *not* public. Such companies have fewer restrictions on how they can operate and are often smaller or more speculative (though not always, mature private companies do exist). Because trading a private company’s shares is more difficult because of the lack of an open market, private equity investments tend to be for larger dollar amounts and intended to be held for a long period of time (years, typically).
One common example of private equity is venture capital, where investors buy part of a young and speculative business in the hopes that it will grow rapidly; most startups are funded by venture capital.
Private equity firms are investment funds that focus almost exclusively on ownership of the equity of privately-owned companies, rather than publicly-owned companies, like those you’d see listed on public exchanges like the NYSE, NASDAQ. Venture capital is a form of private equity, but for this, I’ll focus on the kind of fund most people are referring to when they say “private equity.*
The general characteristics of PE:
– investments **only in private companies**;
– ownership of a **significantly larger proportion of a company’s total equity** (most often a controlling interest, or greater than 50% of the company’s equity);
– investments are **most often funded with a mix of cash and debt** (often, more debt than cash);
– the PE firm makes the investment based on its **plans for how to steer the company toward greater growth or profitability in the future** (the *”investment thesis”); thus
– **takes an active role** in the management of the company (not necessarily in managing day-to-day, but in proposing, vetting, approving, and implementation major strategic initiatives, expansion, acquisitions, hiring, new product introductions and/or sunsetting old products, entrance to new markets, changing production and suppliers, etc.); and
– generally plans to **hold these investments for moderately long periods** (5-7 years).
There are exceptions to every one of these points, as PE is widely varied, but each of these things are generally *not* done by investors in public companies.
As for *why* private vs. public equity, the simple answer is that it’s about increasing control over your investments, while having the potential to generate higher returns (think 30-40% rates of return) than are seen in the public markets as a whole (low-mid teens). This comes with additional risk, but the PE firm and its investors are willing to take those risks for the possibility of outsized returns.
I can explain certain elements in greater detail, if you’d like, including explaining why public and private equity markets exhibit such different characteristics, and why there two markets in the first place.
Most companies are valued highest by many shareholders after going public, but sometimes the public sours on a company or industry like gasoline auto manufacturing today. When that happens the price of the company can fall enough that it can be a target of people who want to buy the company entirely.
Sometimes they’ll make difficult steps to shrink the company or they will sell of part and separate parts, or sometimes they’ll shut down the whole thing to gain a few assets that are worth more than they paid for the whole company (think of a headquarters tower or something).
Private equity tends to be ruthless about doing the most valuable thing with what’s left of the company which can include closing most or all of the business which means lots of layoffs, so it tends to have pretty negative associations, but it can just hold businesses until the public values them more as an unchanged operation.
They are companies that raise pools of investment capital to acquire large/controlling stakes in companies or acquire them entirely. Sometimes, they are a means for a founder to extract liquidity from a company as they get to retirement age or focused on estate planning (Here in Chicago, regional restaurant chain Portillo’s sold part of the company to a PE firm about 15 years ago, then the rest of the company a few years later when owner retired. The PE firm funded expansion to new markets, then an IPO). Often, they target companies that seem to be lagging their peers or ripe for operational improvement, so that the companies can be sold or IPOed for a profit after a turnaround. Other times, the companies are acquired to dismantle and sold off division by division, etc. to extract more value. Sometimes, they seem to be nothing more than grave robbers, acquiring companies, extracting assets while saddling the company with debt that kills it off (ie. Toys R Us).
Latest Answers