Private Equity Overview Vikas Lonakadi
“Private Equity” is exactly what is sounds like: an equity (ownership) position that is private (not tradable in any public market). Over the last few years, private equity has been getting increasingly large amounts of media attention, as increasingly aggressive firms acquire larger companies and poach better talent away from mainstream management. With the pending IPO of the Blackstone Group, and the presidential candidacy of Mitt Romney, the former CEO of Bain Capital (one of the largest private equity firms), it does not look like the attention will abate anytime soon.
As can be easily ascertained, the label “private equity” is incredibly broad, and encompasses business practices such as leveraged buyouts, angel investing, and venture capital. Until recent times, private equity firms have been small and fairly out of the limelight. They invested in companies that were not listed publicly at all, and took an active role in management in an attempt to raise the value of the businesses. During the 1990s, private equity firms were active in the dot-com boom, and remain involved in technology startups.
Thus, one way that private equity operates is by investing in high-risk, small-cap companies and getting involved in management. Bain Capital was able to start companies such as Staples and Dominos Pizza through this track. The second way is by purchasing struggling public companies. Larger private equity companies, such as The
Blackstone Group, will buy out a company’s stock, and delist it from the public stock exchange. Then, these private equity firms will use an experienced and talented management staff to completely restructure the company and fix any problems they can, thereby raising its value. Finally, the PE firm will issue an IPO and reintroduce the company to the market, or sell the restructured business to a high bidder.
Private equity is incredibly risky, as the stock price of a company during a buyout can jump substantially, the restructuring may be expensive or unsuccessful, and the final sale unprofitable. Compounding these issues is the fact that capital in a private equity firm is essentially locked for a significant period of time, while the bought out company is undergoing restructuring and reevaluating. But a good private equity firm can outperform the market consistently, which makes it an attractive target for investors. Compensation at a private equity firm is similar to a hedge fund, with a general manager receiving a “2 and 20” pay package. But unlike hedge funds, the primary investors in private equity firms are not wealthy individuals, but rather endowments, pension funds, and other trusts looking for a long-term return on investment.
The recent success of the private equity industry and the fact that successful restructuring hinges on strong management talent has led many firms to “poach” top managers from traditional companies. The pay at private equity firms can be incredibly high, and the work very fast-paced rewarding (management of a bought-out firm is virtually unrestricted and unregulated by both the public and the government). However, a strong
understanding of accounting, good insight into business strategy, and an excellent knowledge of the industry is essential for success.
In all, private equity has the potential – and the probability – for incredible growth over the next few years. The expected IPO of top firms, combined with an increased appetite for risk-taking and reforming also means that there will be a market for top talent.