What Is Private Equity?

What Is Private Equity and Why Should You Care?

If you are interested in investing or business, you may have heard of private equity (PE) as a source of capital and a way to create value. But what exactly is private equity and how does it work?

In this resource, we will explain the basics of private equity, its benefits and risks, and some examples of how it operates in the real world.

Private Equity Basics

Private equity is a form of financing where public or private companies accept investments from a PE fund, which is a pool of money raised from institutional and accredited investors. Accredited investors are individuals or entities that meet certain criteria of income, net worth, or professional experience, and are deemed to have the financial sophistication and ability to evaluate and bear the risks of alternative investments.

See the Private Equity Investor Glossary

PE funds typically invest in mature businesses in more conventional industries, such as manufacturing, retail, healthcare, or technology. They may also target companies that are struggling or undervalued, and aim to improve their performance by restructuring their operations, management, or strategy. PE funds usually acquire a significant or controlling stake in the companies they invest in, and take an active role in their governance and decision-making.

The main goal of private equity is to generate returns for the investors in the PE fund, as well as for the PE firm itself, which charges fees and receives a share of the profits.

Read More: Understanding Internal Rate of Return in Private Equity >

PE funds have a finite lifespan of 7 to 10 years, during which they make investments, manage their portfolio companies, and exit them by selling them to another company, taking them public again, or distributing their shares to the investors.

Benefits of Private Equity

Private equity can offer several advantages for both investors and businesses.

• Access to alternative asset classes.
• Strong annual returns.
• Flexibility compared to bank loans or public equity.
• Business network and expertise.

For investors, private equity can provide access to alternative asset classes that are not correlated with the public markets, and that can potentially offer higher returns than traditional investments. In any PE investment, there is a general partner who is the driving force behind a fund and a limited partner who has limited risk exposure.

According to Investopedia, private equity funds have delivered relatively strong returns since 2000, averaging 13.5% annually as of 2020.

For businesses, private equity can provide a source of capital that is more flexible and patient than other forms of financing, such as bank loans or public equity. Private equity can also bring expertise, connections, and strategic guidance that can help businesses grow, innovate, or overcome challenges.

Read More: How Carried Interest Impacts Your PE Investment >

Risks of Private Equity

However, private equity also involves significant risks and challenges for both investors and businesses.

• Liquidity is usually a challenge for private equity firms and investors.
• Some forms of investments are speculative.
• Loss and returns depend largely on the portfolio company.
• For businesses, private equity is another form of debt with all the associated risks of leverage.

For investors, private equity is illiquid, meaning that they cannot easily withdraw their money from the PE fund until it exits its investments. Private equity is also highly speculative, meaning that it involves a high degree of uncertainty and volatility. Private equity investments can result in substantial losses if the portfolio companies fail to perform or if the market conditions change unfavorably.

For businesses, private equity can entail a loss of control and autonomy over their operations and strategy, as they have to answer to the PE fund and its interests. Private equity can also impose high levels of debt on the businesses they acquire, which can increase their financial risk and limit their ability to invest in growth or innovation. Private equity can also have negative social impacts, such as layoffs, outsourcing, or environmental damage.

How Private Equity Works in the Real World

To illustrate how private equity works in practice, let us look at some examples of well-known PE deals.

Blackstone Group Acquired Hilton Hotels

In 2007, Blackstone Group Inc., one of the largest and most prominent PE firms in the world, acquired Hilton Hotels Corporation for $26 billion – a private equity real estate trend that’s quite common these days.

Blackstone invested $5.5 billion of its own capital and borrowed the rest from banks. Blackstone improved Hilton’s performance by expanding its global presence, enhancing its brand portfolio, and increasing its efficiency.

In 2013, Blackstone took Hilton public again in one of the largest hotel IPOs ever . In 2018, Blackstone sold its remaining stake in Hilton for $1.3 billion, making a total profit of about $14 billion on its initial investment.

Dell Goes Private with a PE Firm

In 2013, Dell Inc., one of the leading computer manufacturers in the world, went private in a $24.9 billion deal led by its founder and CEO Michael Dell and Silver Lake Partners a PE firm focused on technology investments.

The deal was financed by $13.75 billion of debt from banks. Dell and Silver Lake aimed to transform Dell from a PC maker into a provider of enterprise solutions and cloud services.

In 2018, Dell announced its plan to go public again by buying out its tracking stock for VMware Inc., a software company that Dell acquired in 2016. The deal valued Dell at $21.7 billion, implying a modest return for Dell and Silver Lake.

Burger King Inc and Tim Hortons Inc Use Private Equity to Merge

In 2014, Burger King Worldwide Inc., one of the largest fast-food chains in the world, merged with Tim Hortons Inc., a Canadian coffee and doughnut chain, in a $12.5 billion deal backed by 3G Capital, a PE firm known for its aggressive cost-cutting and consolidation strategies.

The deal was financed by $9.5 billion of debt from banks and Warren Buffett’s Berkshire Hathaway Inc. The merger created Restaurant Brands International Inc., the third-largest quick-service restaurant company in the world.

In 2017, Restaurant Brands acquired Popeyes Louisiana Kitchen Inc., another fast-food chain, for $1.8 billion. As of 2021, Restaurant Brands had a market capitalization of about $30 billion, indicating a substantial value creation for 3G Capital and its co-investors.

How Private Equity Works

As you can see, private equity is a complex and dynamic field that can have significant impacts on the economy and society. Private equity can offer opportunities for investors and businesses to achieve growth, innovation, or transformation, but it can also entail risks, challenges, or trade-offs. There are clear trends in private equity you should be aware of before investing or borrowing.

If you are interested in learning more about private equity, you can check out some of the sources and links below.

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Sources and Links:

https://www.investopedia.com/terms/p/privateequity.asp
https://www.blackstone.com/
https://www.nytimes.com/2007/07/04/business/04hilton.html
https://www.wsj.com/articles/hilton-prices-ipo-at-20-a-share-1386807096
https://www.reuters.com/article/us-hilton-blackstone/blackstone-sells-last-stake-in-hilton-for-1-3-billion-idUSKCN1LZ2QO
https://www.bloomberg.com/news/articles/2018-09-19/blackstone-s-hilton-sale-marks-end-of-a-14-billion-profit-run
https://www.dell.com/
https://www.silverlake.com/
https://www.nytimes.com/2013/02/06/technology/dell-sale-signals-a-shift-in-tech.html
https://www.reuters.com/article/us-dell-lbo-banks-idUSBRE9150X120130206
https://www.forbes.com/sites/antoinegara/2018/07/02/the-inside-story-of-michael-dells-24-billion-bet-to-transform-his-company/?sh=4a0c0f2b4c9a
https://www.wsj.com/articles/dell-nears-deal-to-buy-out-vmware-tracking-stock-with-cash-and-equity-1530543072
https://www.cnbc.com/2018/12/28/dell-set-to-go-public-on-december-28.html
https://www.bk.com/
https://www.timhortons.com/
https://3g-capital.com/
https://www.ft.com/content/bfbd0d9e-6b29-11e4-be68-00144feabdc0
https://www.wsj.com/articles/burger-king-in-talks-to-buy-tim-hortons-in-canada-tax-deal-1408962641
https://www.rbi.com/
https://www.reuters.com/article/us-popeyes-m-a-rstrnt-brnds-intl-idUSKBN1601GD
https://finance.yahoo.com/quote/QSR/