The huge sums that private equity firms make on their investments evoke admiration and envy. Typically, these returns are attributed to the firms’ aggressive use of debt, concentration on cash flow and margins, freedom from public company regulations, and hefty incentives for operating managers. But the fundamental reason for private equity’s success is the strategy of buying to sell—one rarely employed by public companies, which, in pursuit of synergies, usually buy to keep.
The chief advantage of buying to sell is simple but often overlooked, explain Barber and Goold, directors of the Ashridge Strategic Management Centre. Private equity’s sweet spot is acquisitions that have been undermanaged or undervalued, where there’s a onetime opportunity to increase a business’s value. Once that gain has been realized, private equity firms sell for a maximum return. A corporate acquirer, in contrast, will dilute its return by hanging on to the business after the growth in value tapers off.
Public companies that compete in this space can offer investors better returns than private equity firms do. (After all, a public company wouldn’t deduct the 30% that funds take out of gross profits.) Corporations have two options: (1) to copy private equity’s model, as investment companies Wendel and Eurazeo have done with dramatic success, or (2) to take a flexible approach, holding businesses for as long as they can add value as owners. The latter would give companies an advantage over funds, which must liquidate within a preset time—potentially leaving money on the table.
Both options present public companies with challenges, including U.S. capital-gains taxes and a dearth of investment management skills. But the greatest barrier may be public companies’ aversion to exiting a healthy business and their inability to see it the way private equity firms do—as the culmination of a successful transformation, not a strategic error.
FAQs
Private equity firms commonly deploy various strategic approaches to achieve their investment objectives. These strategies encompass A) leverage buyouts, B) growth capital investments, C) venture capital initiatives, D) secondaries, and E) fund of funds structures.
What is a strategic in private equity? ›
While strategic buyers are interested in absorbing sellers into a larger corporate entity, private equity buyers are more interested in growing your company's revenue and profit over several years before selling it as part of a larger consolidate entity. Naturally, this goal impacts the experience of the seller.
What to say when asked why private equity? ›
What to Include in Your Answer to “Why Private Equity?”
- Highlight that you have some transaction experience.
- Express an interest in a sector that the PE firm invests in.
- Position yourself as a long-term thinker or investor.
- Show that you know what the PE firm has invested in.
Private equity owners make money by buying companies they think have value and can be improved. They improve the company or break it up and sell its parts, which can generate even more profits.
What is the 2 20 rule in private equity? ›
Key Takeaways
Two refers to the standard management fee of 2% of assets annually, while 20 means the incentive fee of 20% of profits above a certain threshold known as the hurdle rate.
What are the 4 main areas within private equity? ›
Equity can be further subdivided into four components: shareholder loans, preferred shares, CCPPO shares, and ordinary shares. Typically, the equity proportion accounts for 30% to 40% of funding in a buyout. Private equity firms tend to invest in the equity stake with an exit plan of 4 to 7 years.
Which of the following is most likely a private equity strategy? ›
Answer C) leveraged buyout. Explanation C is correct. A type of private equity fund that invests in established profitable and cash generative companies with solid customer bases, proven products, and high quality management is most likely described as a leveraged buyout.
What is private equity explained simply? ›
What Is Private Equity? Private equity describes investment partnerships that buy and manage companies before selling them. Private equity firms operate these investment funds on behalf of institutional and accredited investors.
What is private equity easily explained? ›
Private Equity Defined
Private equity funds raise money from outside investors and use the money to acquire companies, taking a hands-on approach to improve their business, and then in 5 to 10 years' time, to resell them, hopefully, at a profit.
How do you stand out in a private equity interview? ›
Show your personality: Headhunters meet with dozens of investment bankers every day, so you need to be able to stand out with your own unique personality. Beyond the actual interview, create small talk with all of the people you meet at the headhunting firm and be able to talk about more than just finance.
Since private equity funds have far more control in the companies that they invest in, they can make more active decisions to react to market cycles, whether approaching a boom period or a recession. The result is that private equity funds are more likely to weather downturns.
Why is private equity hard? ›
Private equity professionals work long hours and are highly competitive and must think critically, and have a passion for financial investing deals, not just following the markets. Other requirements to start a career in private equity are: Excellent grades and a notable transcript in school.
How much does the average person in private equity make? ›
What is the Average Salary in Private Equity?
| Private Equity Salary Data | | |
|---|
| 2nd Year Associate | $160k – $180k | $170k – $270k |
| 3rd Year Associate | $180k – $200k | $180k – $300k |
| Senior Associate | $200k – $220k | $210k – $390k |
| Vice President (VP) | $230k – $260k | $340k – $520k |
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Private equity funds are illiquid and are risky because of their high use of debt; furthermore, once investors have turned their money over to the fund, they have no say in how it's managed. In compensation for these terms, investors should expect a high rate of return.
Is private equity ruthless? ›
Private equity firms earned a reputation for being ruthless profiteers during the 1980s. Their investment style was even lampooned in “Barbarians at the Gate,” a dark comedy based off KKR's hostile takeover over RJR Nabisco.
What is the investment strategy of a private equity fund? ›
Private equity funds give investors a way of investing in a portfolio of private companies by providing capital to drive growth, expansion or restructuring. These vehicles help investors gain exposure to private markets which they may use to complement allocations to public market investments.
What is a strategy used by private equity firms looking to generate value and grow their returns? ›
The buy and build strategy is common among private equity firms with a short holding period of between three and five years. When investors put their funds into private equity, they do so expecting a reasonable amount of interest after an agreed period of time.
What are the three ways to make money in private equity? ›
Private equity firms make money through carried interest, management fees, and dividend recaps. Carried interest: This is the profit paid to a fund's general partners (GP).
