Example of Private Equity Firm:
A private equity fund, ABC Capital II, borrows $9bn from a bank (or other lender). To this it adds $2bn of
± money from its own partners and from
(pension funds, rich individuals, etc.). With this$11bn it buys all the shares of an underperforming company, XYZ Industrial (after
, i.e. checkingthe books). It replaces the senior management in XYZ Industrial, and they set out to streamline it. Theworkforce is reduced; some assets are sold off, etc. The objective is to increase the value of the company for afast sale. The stock market is experiencing a bull market, and XYZ Industrial is sold two years after the buy-outfor $13bn, yielding a profit of $2bn. The original loan can now be paid off with interest of say $0.5bn. Theremaining profit of $1.5bn is shared among the partners. Taxation of such gains is often minimal. Note that partof that profit results from turning the company round, and part results from the general increase in share pricesin a buoyant stock market, the latter often being the greater component. Notes:
The lenders (the people who put up the $11bn in the example) can insure their loans against default, at acost, by selling credit derivatives; including credit default swaps (CDSs) and collateralized loanobligations (CLOs), to other institutions, such as hedge funds.
Often the loan/equity ($11bn above) is not paid off after sale but left on the books of the company (XYZIndustrial) for it to pay off over time. This can be advantageous since the interest is typically off-settableagainst the profits of the company, thus reducing, or even eliminating, tax.
op 5 Advantages of Private Equity
Investing in a private equity fund has a lot of advantages compared to other investment areas; here are just fiveadvantages of private equity for not only investors but also the companies that private equity firms acquire:1.
Companies that are backed or acquired by private equity firms are often made more efficient and produce higher profits, which benefits now only the private equity firm but also the company. Privateequity firms use skilled management teams to correct the problems and ineffective parts of the companyand many times this intervention prevents the company from further declining or even failing.2.
The management receives carried interest, a portion of the profits, so managers and their staff aremotivated to produce good results to investors. Although carried interest is often criticized for takingmoney from the investors, it is a very big incentive for managers.3.
By definition, private equity firms work outside the public eye and do not have to follow the sametransparency standards that public firms and funds must adhere to. This allows private equity firms toreform the companies without the constraint of having to report quarterly to the SEBI or ROC or similar distractions.4.
Private equity firms generally perform very rigorous due diligence on potential investments. By utilizinga team of researchers the private equity firm is able to identify most risks that would not otherwise befound.5.
Private equity managers are paid very well and so it is easy to attract high caliber, experienced managersthat tend to perform very well. The same goes for lower level employees at private equity firms, theytend to be the top young business school graduates.