What is Private Equity?
Private equity refers to investment partnerships that acquire, manage, and eventually sell companies for a profit. These firms run private equity funds on behalf of institutional and accredited investors. They can take over private companies or public ones entirely and typically avoid holding stakes in companies listed on stock exchanges.
Actionable Takeaways
- Private equity firms buy companies, overhaul them, and sell them at a profit.
- Funding comes from outsiders, often supplemented by debt.
- The industry’s popularity rises when stock prices are high and interest rates are low.
- Private equity acquisitions can either make companies more competitive or burden them with debt, depending on the firm’s expertise and objectives.
Inside the World of Private Equity
Unlike venture capital that targets startups, private equity usually invests in mature companies. They manage and improve these companies, intending to increase their value before exiting the investment years later. The industry has seen rapid growth, especially when stock markets boom and interest rates dive. Notable performance includes private equity buyouts totaling $654 billion in 2022, making it the second-best year historically.
Private equity leaders, acting as general partners, manage these funds in exchange for fees and a share of profits. These funds typically last 10 to 12 years, with returns distributed to investors after a few years.
Specialties in Private Equity
Certain firms focus on specific types of deals. They include:
- Distressed investing: Targeting financially struggling companies.
- Growth equity: Investing in companies beyond the startup phase.
- Sector specialization: Focusing on specific industries like technology or energy.
- Secondary buyouts: Acquiring companies from other private-equity firms.
- Carve-outs: Buying divisions of larger corporations.
Breakthrough Deals
Private equity deals can transform companies dramatically. Buyouts often involve entire companies, restructuring public companies, or acquiring non-core divisions. For instance, Carlyle’s 2014 acquisition of Tyco Fire \& Security Services Korea Co. Ltd. or Francisco Partners’ acquisition of Litmos in 2022.
Value Creation: The Heartbeat of Private Equity
Private equity firms usually predetermine plans when acquiring firms, often implementing cost cuts or restructurings. Operational enhancements, technology adoption, and market expansion are common steps. Their expertise can greatly contrast with the previous management’s approach, aligning more aggressive value-add strategies.
Debt often plays a critical role, magnifying potential returns but adding risk. Some firms may even use dividend recapitalization to extract value quickly by incurring extra debt, sparking both execution excellence and controversy.
Criticisms and Regulatory Landscape
Despite their positive transformations, private equity faces criticism for rapid changes impacting employees and communities. Carried interest taxation and pushes for ESG standards further spur debate. Moreover, while private equity funds are exempt from certain SEC regulations, their managers must disclose performance, fees, and potential fund-specific advantages to maintain transparency and fairness.
The Legacy and Regulation of Private Equity
High-profile deals date back to 1901 with J.P. Morgan’s Carnegie Steel acquisition. Henry Ford and KKR’s influential deals further illustrate private equity’s rich history. Today, regulations require extensive reporting and client disclosures for fund managers to ensure transparency and prevent conflicts of interest.
Conclusion
Private equity bridges transformation and potential conflict in company ownership. Although instances of self-interest arise, and challenges endure, private equity remains pivotal in generating value and driving business success. Adaptation to sensible regulation ensures its enduring relevance in global market economies.
Related Terms: venture capital, hedge funds, alternative investments.
References
- U.S. Securities and Exchange Commission. “Accredited Investor Net Worth Standard”.
- CAIA Association. “Strategic Portfolio Construction with Private Equity”.
- Bain & Company. “Private Equity Outlook in 2023: Anatomy of a Slowdown”.
- Dealogic. “M&A Highlight: Full Year 2021”.
- Moonfare. “What We Learned About Private Equity in H1 2022”.
- S&P Dow Jones Indices. “S&P Listed Private Equity Index”. Chart View: 10Y; Compare: S&P 500.
- Kohlberg Kravis Roberts & Co. “Unlocking Private Equity”.
- Congressional Research Service. “Taxation of Carried Interest”. Pages 2-3.
- Kohlberg Kravis Roberts & Co. “Unlocking Private Equity”. Select Life Cycle of a Private Equity Fund.
- Private Equity Info. “Holding Periods Reach Record Highs as Private Equity Recovers from COVID-19”.
- U.S. Securities and Exchange Commission. “Form S-1, The Blackstone Group L.P., As Filed with the Securities and Exchange Commission on March 22, 2007”.
- S&P Global. “Private Equity Firms Go Public as Valuations Soar, Retail Investors Buy In”.
- Carlyle. “The Carlyle Group Agrees to Acquire ADT Korea from Tyco for $1.93 Billion”.
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- PwC. “Driving Transformative Value Creation in Private Equity Carve Outs”.
- Harvard Law School Forum on Corporate Governance. “Private Equity Carve-Outs Ride Post-COVID Wave”.
- PitchBook. “How Secondary Buyouts Became Ubiquitous: SBOs as an Exit and Deal Sourcing Strategy”.
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- 10X. “Private Equity Buyout Strategies That Generate Superior Returns”.
- McKinsey & Company. “Private Equity Exit Excellence: Getting the Story Right”.
- Moonfare. “Five Real-World Examples of Private Equity Creating Value by Improving Companies”.
- KPMG. “Delivering on the Promise of Value Creation”.
- The New York Times. “Private Equity Firms Are Piling On Debt to Pay Dividends”.
- Oaktree Capital Management, L.P. “Case Study: Elgin National Industries”.
- Bain & Company. “Limited Partners and Private Equity Firms Embrace ESG”.
- Davis, Steven J. and et al. “The Economic Effects of Private Equity Buyouts.” National Bureau of Economic Research, Working Paper 26371, July 2021, pp. 1-89.
- The New York Times. “The Carried Interest Loophole Survives Another Political Battle”.
- Fogelström, Erik and Gustafsso, Jonatan. “GP Stakes in Private Equity: An Empirical Analysis of Minority Stakes in Private Equity Firms”. MSc Thesis in Finance, Stockholm School of Economics, pp. 1.
- Harvard Business School, Baker Library, Bloomberg Center. “The Founding of U.S. Steel and the Power of Public Opinion”.
- Carnegie Corporation of New York. “Andrew Carnegie: Pioneer. Visionary. Innovator”.
- The Henry Ford. “Henry Ford: Founder, Ford Motor Company”.
- Financial Times. “Memories From Barbarians at the Gate”.
- U.S. Securities and Exchange Commission. “Private Fund”.
- U.S. Securities and Exchange Commission. “SEC Proposes to Enhance Private Fund Investor Protection”.
- U.S. Securities and Exchange Commission. “Proposed Rule: Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews”.
- Kirkland & Ellis. “SEC Proposes Sweeping Rule Changes for Private Fund Advisers (Part 1 of 2)”.
