Private equity, explained
While anyone with a little money can invest through the public stock markets, private equity (PE) firms collect money privately — typically from institutions and very wealthy people — and make direct investments with it, bypassing the public markets. Here’s a brief introduction to private equity.
The private equity world includes businesses such as hedge funds and venture capital (VC) outfits. But typically, the term “private equity” refers to companies specializing in leveraged buyouts (LBOs). The premise of a leveraged buyout seems promising: A private equity firm will raise money from private investors and buy out companies that are struggling (or that have great growth potential). The PE firm offers funding that can help the acquired companies get back on their feet and/ or grow faster, and it may offer sound guidance and cost-cutting advice, as well.
The problem, in the eyes of many critics, is that these buyouts are accomplished with a lot of debt, and that debt is actually held by the acquired company. (In financial lingo, “leveraged” means owing debt.) Thus, the acquired company is on the hook for substantial debt repayments, and that can hinder its ability to get back on track and grow. Sometimes, extra debt is taken on in order to pay dividends to the private equity owner. Can you see how this is often not a great situation for the acquired company? Not surprisingly, many of the targets end up failing.
Private equity firms often have a short-term view regarding the companies they buy: They want to make the companies more valuable — and then sell them at a profit to another buyer or to the public, via an IPO. Thousands of workers have been laid off following LBOs in order to cut costs.
The largest private equity firms, ranked by assets under management, are The Blackstone Group, Kohlberg Kravis Roberts (KKR), The Carlyle Group, Apollo Global Management and CVC Partners. High-profile LBOs include KKR’s purchase of RJR Nabisco in 1988 and Blackstone’s purchase of Hilton in 2007.