Understanding Private Equity

Private Equity Groups are no longer out of the ordinary. There are bids almost every day by these so called “locusts” or “asset strippers” and the value of US buyouts alone in the year 2006 reached $410 billion dollars. Yet large Private Equity houses like Blackstone, Carlyle, KKR and Texas Pacific Group are not keen on seeking the spotlight which is why not many people know about this still young sector. To help bring this sector out of the shadows we will first talk about what Private Equity involves and then how it acts.

Private equity incorporates several categories of private investment. There is leveraged buyout, venture capital, angel investing, growth capital, and mezzanine capital. Private equity broadly refers to any type of equity investment (buying ownership or part ownership of a company) “in which the public equity is not freely tradable on the public stock market.” Leveraged buyout is making the most news currently as it uses debt (up to records of $44 billion dollars in February 2007) to gain control of a target company’s equity. Venture capital is a pooled investment that usually invests in new, start-up and usually technology oriented companies that are too risky for standard capital markets or bank loans. Angel investing is very similar to venture capital except that it is one affluent individual who invests his own capital instead of capital from a pooled investment. There are many nuances of private equity only because there is a lot of money to be made in this industry. Investments here carry a lot of risk but also a lot of reward.

Knowing what private equity is should now help to understand how it works. Toby Poston of BBC compares private equity to groups to house buyers or real estate investors who are looking for bargains. The bargains are business’s that are undervalued by the market or by their owners that can be improved or companies in new high potential areas. Unlike normal homeowners, Poston says, “private equity firms do not settle in. they look for a quick, profitable sell, usually within 3-7 years.” Often they will make an acquisition and take a company private (de-list it if currently quoted on a stock market), where it will be easier for them to make necessary decisions without having to deal with “angry” shareholders or adhere to tough disclosure rules. After an acquisition they are accountable to only the few private investors and lenders in their fund. As leveraged buyout groups are now capable of buying large scale companies and taking them private, these groups can be seen as “barbarians at the gate” seeking to cut jobs and strip assets to squeeze profit out of an organization. What effect do these organizations then have on the economy and what is in the future for them? I will explore these questions next week.

Sources:
-Wikipedia ~private equity
-Financial Times ~ “Secretive sector steps into the glare of publicity”
-FT ~ “Things may start to look murkier”
-BBC ~ “The private equity roller coaster”