Private Equity 101
I’m sure after following the markets you have heard of private equity firms like KKR, Apollo, Carlyle and others. I have heard some confusion regarding what it is they really do, so I will try to demystify this opaque industry for you. In short private equity is buying stock or ownership in private companies, and selling these stakes at a profit. To start, there are a few different types of private equity firms, even venture capital can some times fall under the private equity umbrella. The most traditional is the buy-out firm. These firms typically target larger private companies with stable cash flows, and perform leveraged buyouts, which I will explain in further detail. These firms buy majority control of these businesses or even the entire business. Growth equity firms as the name suggests try to grow their portfolio companies. These firms can typically buy minority stakes in business, however can sometimes buy controlling stakes. Growth equity firms target companies between the maturity necessary for a leveraged buyout and start ups. Venture capital firms are technically a form of private equity. These firms typically purchase a small stake in start up companies.
In this article we will focus on typical leveraged buyout private equity. The main differences between leveraged buyout firms and the other types of private equity is that leveraged buyout firms use debt to buy companies, and they buy for control of the company. A leveraged buyout is a method of buying a company to amplify returns using debt. For example, if a private equity firm wants to buy a company for $100 million and sells it for $120 million, the firm achieves a 20% return. However if the firm buys a company for $100 million but uses 50% debt, and sells the company for the same $120 million with the debt paid off, the firm makes a 140% return. The unique thing about leveraged buyouts is the debt used to acquire the company, goes on the company’s balance sheet and is paid off by that company.
I am not a financial advisor and my comments should never be taken as financial advice. Investments come with risk, so always do your research and analysis beforehand.