What is private equity?
Private Equity is one of the most vaunted types of work in finance. The typical route intois after having spent 2 years at a top and / or completing an MBA at a top business school. For an excellent insight into the Private Equity world, read “ ” which details the of R.J.R. Nabisco by in the 1980s.
What Is Private Equity?Private Equity is not very well known outside of the finance world, but it is one of the key players in global business. Private Equity firms are part of the fabled ‘buy-side’ and some of the largest firms (megafunds) are:
- Kohlberg, Kravis & Roberts ( )
The definition ofis simply money invested into a private company, or the privatization of a company through the investment of outside money. Basically, what firms attempt to do is to invest into a company, take a majority stake, improve the company and then exit their investment at a large profit. In order to magnify returns, PE firms make use of leverage (borrowed money) to conduct Leveraged Buyouts (LBOs).
Private Equity firms can either focus on a specific sector (Energy, Technology, Healthcare etc.) or operate across a broad spectrum. The larger the firm, the more likely it is to cover more sectors.
How Do Private Equity Firms Work?PE firms will typically acquire 100% of the target company and make use of a combination of cash and debt to finance the acquisition. The advantage of using debt is that the firm has to invest less of its own cash, and therefore the return on equity is higher and they can undertake bigger / more investments. When the target company is acquired, the future cash flows are used to pay off the debt used. If the PE firm in question is using leverage, they will require a financial sponsor (typically a bank) to loan them the money.
The aim of the investment by the PE firm is to take a business, increase its value and then sell it’s share in the business. Typically, PE firms will target 20% return per year. The way the firm will improve the business can be anything from replacing the management, reducing costs, improving efficiency or many other possible actions. Private Equity investments are usually not that risky (at least compared to VC) because the target firm is usually quite large and is unlikely to collapse in value.