In its broadest sense, private equity is an investment derived from a nonpublic entity, or private company. These investments differ from those in publicly traded companies that allow investors to purchase shares of stock. Private equity (PE) is much bigger; these investors don’t just invest in stock—they buy entire companies.
In modern private equity, a pool of capital is created from private investors, ranging from university endowments and pension funds to hedge funds, Wall Street investment banks, and high-net-worth individuals. The managers of these private equity pools, or funds, then put that capital to work, generally by purchasing private or public companies, “fixing” them so they generate more revenue, cash, and earnings, and then “flipping” them by selling the improved company to another buyer or taking it public on the equity markets.
Private-equity firms invested $644 billion in U.S.-based companies in 2016, according to the American Investment Council. That year, the top 10 states in terms of investment were Texas,
California, Massachusetts, Florida, New York, Pennsylvania, Illinois, Georgia, Ohio, and Colorado.
Private equity investments aren’t just about buying and selling companies, however. Many private equity firms invest in debt, helping a company salvage itself by loaning it money in exchange for an equity position or another form of return. Some private equity firms target funds at startup companies—these are called venture capital firms, though a diversified private equity management company will often include venture capital activity alongside acquisitions and debt purchases. Venture capital investments are often made in exchange for equity in the private company that the firm hopes will turn into big profits should the startup go public or get sold.
The majority of private equity firms are headquartered in the United States, but opportunities are found throughout the world (especially in Europe). Approximately 4,590 private equity firms have headquarters in the United States. Eight of the top 10 firms in terms of fundraising totals are located in the U.S., according to Private Equity International, a global news service that focuses on the PE industry.
Since the early 2000s, private equity funds have grown tremendously. In June 2017, private equity firms worldwide managed $2.83 trillion in assets, according to The 2018 Preqin Global Private Equity & Venture Capital Report, up from “only” $716 billion in managed assets in December 2000.
Naturally, when dealing with billions of dollars and major corporations, private equity firms need a wide variety of talented employees. And that’s where you’ll come in. Private equity firms employ some of the most experienced talent in corporate America, and their personnel needs are as broad as they are deep. Whether you’re fresh out of undergrad or a seasoned corporate veteran, chances are you can find a home with private equity firms. And in doing so, you’ll have a hand in making billions for your investors while guiding large corporations, and the thousands of people they employ, through major changes and improvements. General partners (which are often the owners of the firm), researchers, and analysts are the major players in this industry, but firms also need sales, legal, compliance, marketing, investor relations, and office support workers. Those with bachelor’s degrees can qualify for administrative support and other entry-level jobs at private equity firms, but top-level PE careers require an MBA. The industry is also seeking workers with degrees in law and accounting, as well as in engineering and science-related fields.
Private equity generally works the same way throughout Wall Street, whether we’re talking about an independent private equity firm, a public firm like The Carlyle Group, or a fund that’s part of a major hedge fund or investment bank (although the Volcker Rule now requires investment banks to have no more than 3 percent of their capital invested in private equity, hedge funds, and other investment funds). Private equity companies, or divisions, have to create a fund and finance it, find potential investments, line up additional financing, make the deal, fix up the company and determine the exit strategy. Here’s a look at how it works.Creating a Fund
Private equity firms can have multiple funds running at the same time. Some are specialized, say in distressed debt or venture capital, while others are simply giant pools of cash the firm can use for any investment it sees fit. To create a fund, of course, the firm has to find cash.
A well-established private equity firm has reasonably dependable sources of capital for its funds. Major banks, pension funds, hedge funds, and other Wall Street stalwarts are generally willing to give a fund several hundred million dollars each to get it started. Major universities and charities are also good sources of funds, since their endowments generally aren’t used for operational purposes. Finally, private wealth management organizations sometimes pool the money of some of their high-net-worth clients—and generally only those who can measure their worth in the hundreds of millions—in order to make a private equity investment.
And of course, the managing directors and ownership of the private equity firm also puts capital into any given fund. For successful private equity investors, that can be valued at several hundred million dollars.
All of these sources of capital, pooled together, create the private equity fund. Major private equity firms can have
more than $10 billion in assets, though outside a handful of these top firms, such funds tend to be in the $2 billion to $5 billion range.
The funds operate much like a mutual fund, in that each participant or entity receives a return on its investment commensurate with the performance of the fund and how much each institution put in. Yet there are notable differences. Private equity firms require major commitments of time for each investment—investors generally must commit their money for up to 10 years. Once a private equity firm acquires funding, they usually have a window of one to three years to deploy their capital by buying companies, and another three to five before investors begin to receive some distributions from the fund. That’s roughly the same lifespan of a major private equity investment, and the private equity firm won’t be able to execute on its strategy without assurance that the money will be there.
Depending on the kind of fund, there may be regular payouts for its investors, but in many cases, investors may have to wait the full term before getting their returns. It’s because of this wait, in part, that private equity investors start levering up their new acquisitions almost immediately upon purchase.
Once a fund is created, the private equity firm then needs to find appropriate investments. Depending on the market environment, the time this takes can vary between weeks and years. Private equity firms are constantly researching possible investments, even before the funds are created. These possibilities, in part, are major selling points for potential investors, who need to be reassured that the fund can put their capital into action as efficiently as possible.
Many private equity firms rely on the networks and relationships of their principles to find investment opportunities. They look for companies or parts of companies to purchase from private owners, often the original entrepreneurs who founded the company. Since these companies aren't publicly traded, less information about them is readily available. Some potential targets are easy to spot—the companies that put themselves up for sale, will attract interest, though these are by no means certain. Some companies may simply not be worth the time and money needed to turn them around, and good research should reveal that.
There are also companies that privately court private equity bidders. Generally, these contacts aren’t made via press release, but are done quietly, with the head of M&A for a major Wall Street firm making a call to a private equity firm’s managing director. Often, the company’s books are laid open to the private equity firm’s researchers, who can then determine if there are enough efficiencies to be gleaned to make an acquisition worthwhile.
In still other cases, private equity firms will explore companies through their public filings and Wall Street analysts’ research, and go to them independently with the potential of a takeover. In some cases, these companies may not have given much thought to a leveraged buyout (LBO)—perhaps they had a longer-term plan to achieve the efficiencies that a private equity firm could make happen much faster, or perhaps they didn’t even see the
potential for the kinds of major improvements a private equity firm might propose. Sometimes a company is the perfect adjunct to another of the private equity firm’s portfolio companies, and the firm seeks to create a private merger between the two, which would boost the value of both once they’re rolled out into the open market.
Occasionally, a private equity firm will spot opportunity in a previously announced deal between two public companies or an LBO by a competitor. If the research shows the company could do a better job of creating value than the existing bidder, the private equity firm might jump in with a higher offer.
And that’s the key to the entire research process—creating value. The private equity firm’s demonstrated expertise must fit well with the target company’s opportunities, and there must be a relatively quick “fix” that will bring the fund’s shareholders value within the three- to five-year time frame. Most firms have several dozen potential opportunities on their “wish list” at any given time, just waiting for the last few pieces of the puzzle to fit into the investment scheme. Sometimes it’s a question of an anticipated failure in a division, other times it’s simply waiting for the stock price to fall enough to make a deal worthwhile.
When the opportunity seems ripe, the researchers and deal makers work together to create a buyout offer. This offer doesn’t simply include a per-share price, but rather is a detailed plan for the company over the life of the buyout firm’s involvement. To a degree, it includes the areas in which the private equity firm can bring additional value to the company, as well as how much the firm plans to invest in the company’s operations. Not all the cards are laid out on the table, however. “You don’t want to just spell out exactly how they can unlock billions in value,” says one longtime private equity negotiator, who asked not to be identified for fear of giving those across the table from him an advantage. “You want to tell them the value is there, and maybe lowball it some, but you want them believing that you’re the only one who can dig it out.”
All of the usual tricks and ploys used in traditional M&A deal making are on display in a leveraged buyout. Both sides can use Wall Street analysts and the broader media to bolster or hurt the target’s share price. The futures of top management at the target firm must be taken into account. Projections of cost savings are bandied back and forth. But in addition to the typical deal-making tactics and rhetoric, private equity firms have a few aces up their sleeve that a public company buyer might not.
For one, private equity buyouts, in many cases, preserve the target company’s identity; it’s not getting swallowed up by a larger rival. They also give current management an opportunity to right the ship without the scrutiny that comes from being a publicly traded company. Since the dot-com bubble burst in 2000-2002 and the Great Recession, many investors have become increasingly insistent that companies “make their numbers” each quarter, surpassing quarterly revenue and profit estimates from Wall Street analysts. If they miss estimates, the stock is punished—sometimes severely. Privately, some CEOs have complained that the drive to make their numbers has hampered their ability to make the necessary long-term investments to drive long-term growth of their businesses. Instead, they hit their numbers and store up cash on their balance sheets to use in share buyback programs and higher dividends to appease public shareholders.
To have a private owner willing to invest for even a three- to five-year time frame would seem like a vacation. And the ability to put free capital back into the company is just good business. It can be a compelling mix, even for the healthiest company.
And for companies not so healthy, a buyout can be a boon in other ways. For one, the infusion of capital from private equity owners can bring about big changes in a short amount of time. Private ownership can also handle the more unpopular chores related to a turnaround, including layoffs and dealing with past creditors. The private ownership can also help top managers save face, especially if they were responsible for distressing the company in the first place. A top manager whose policies may have failed can still leave with his or her reputation intact by creating shareholder value for a buyout, usually by getting a bid with a hefty premium over the current share price. The fact that said management also leaves with a nice golden parachute is also compelling.
Once negotiations start, agreeing to a rough framework of a deal can take months, but in reality it is a two- to four-week process—private equity firms choose their targets carefully, after all. Once an agreement in principle is reached, it’s announced to the general public and the target’s management gets to enjoy the subsequent boost in share price. From there, months of additional negotiations take place, during which time the private equity firm gets a complete accounting of the company’s operations and financial health, and the final details on layoffs, compensation, operational adjustments, and finances are all ironed out. The deal then goes to the target’s shareholders for approval. Once that happens, the private equity firm pays each shareholder the agreed-upon amount per share, and the company officially becomes a private entity owned by the takeover firm.