👋🏼 everyone,
When someone says they work in private equity, it's like they're speaking a foreign language. Most people have no idea what they actually do all day, and assume it's just another way of saying "I make a lot of money."
At the same time, private equity often gets a bad rap. I've had many conversations prior to joining a PE-backed company, which I've done twice in my career so far, that have gone along the lines of:
"umm, watch out, they'll work you to the bone"
"They're going to be all over the management team and that (stress) is going to trickle down through the organisation."
"Be prepared for ruthlessness".
With all that said, you might ask, is there anything good about private equity? In short, the answer is most definitely yes.
Today I am going to cover:
A quick explanation of private equity
How do private equity firms raise money for their funds?
📹 explanation
Step-by-step guide on how private equity works
Why private equity should matter to you
🤔 Common misconceptions
Key roles in private equity firms
(Quickly) Explained…
Private equity is like being a partner in a business. Just like how you would invest in a friend's business to help them get started, private equity firms invest in existing businesses to help them grow and become more profitable.
In return, the private equity firm gets a share of the profits. They might even take an active role in helping the business succeed, by offering advice or resources to improve operations. This can be a win-win situation for both the private equity firm and the business, but it also involves risks and challenges. Ultimately, the goal is to create value and generate returns for the investors who put money into the private equity fund.
The fund is simply the pool of money managed by the PE firm. This fund is used to invest in companies.
🔍 How do private equity firms raise money for their funds?
Here’s just a few examples of where PE firms get their money:
🧍🏼♀️High net worth individuals: Wealthy individuals like successful business owners, top executives, or people who inherited a lot of money, often invest in private equity funds.
💴 Retirement funds: Pension funds, which manage money for people's retirement, may choose to invest in private equity as a way to make more money.
🏫 Schools and charities: Educational institutions and non-profit organizations that manage endowments may also invest in private equity to earn more money for their causes.
🌱 Philanthropic foundations: Some private equity funds are supported by foundations that invest in businesses that do good for society.
👨🏻💼 Insurance companies: Insurance companies may invest in private equity to make more money and diversify their investment portfolios.
🏢 Government funds: Governments may have special funds called sovereign wealth funds, which can invest a lot of money in private equity firms.
💰Wealthy families: Rich families may create their own investment offices (called family offices) and put money into private equity funds as part of their strategy.
🏦 Banks and financial institutions: Private equity firms may also borrow money from banks and other financial institutions to invest in businesses.
Private equity…in 90 seconds:
A step by step guide of how private equity works:
As mentioned above, private equity firms raise funds (money) from institutional investors such as pension funds, insurance companies and wealthy individuals.
They use these funds to buy stakes in private companies that they believe have the potential for growth or improved profitability.
Once the private equity firm acquires the company, it works closely with the management team to make operational improvements, reduce costs and grow the business. This is sometimes where PE firms get their bad reputation. For example it’s at this stage, they might push for job cuts to make the organisation more profitable.
After a few years, typically 3-7 years, the private equity firm seeks to exit the investment by selling its stake, either through an initial public offering (IPO), a sale to another company, or a sale to another private equity firm.
If the private equity firm is successful in improving the performance of the company, it can generate significant returns for its investors, typically in the form of capital gains.
Why should you care about private equity?
OK, so the average person may not directly invest in private equity, but understanding its importance in the broader economic sense is useful as it will almost certainly touch your life in some shape or form:
Job creation 📈 Private equity firms often invest in companies that have the potential to grow and create jobs, which can benefit individuals and communities.
Consumer impact 🏷️ Private equity ownership of companies can affect the products and services offered to consumers, as well as the prices of those products and services.
Corporate responsibility: Private equity firms can influence the corporate responsibility practices of the companies they invest in, including their environmental, social, and governance practices. They can have a LOT of influence over the company.
Pension funds: Private equity investments are often held in pension funds, which can affect the retirement savings of individuals.
Economic impact 🚀 Private equity can have a significant impact on economic growth and development, as it provides capital to support innovation, new technologies, and infrastructure projects.
🤯 Common misconceptions about private equity:
≠ Private equity and venture capital are the same thing
No they are not. Venture capital funds tend to invest in newer and smaller companies, often start-ups or technology companies, while PE funds invest in more established companies, usually with some profit history.
😫 Private equity investors only invest in companies in financial distress
Some specialise in buying distressed companies with the aim of turning them around and then selling them on at a profit. This is more of a hedge fund strategy, but private equity fund managers will look for companies that can be bought at a good price (not necessarily in distress) and where they can add value, such as through mergers or new businesses.
👋🏼 Once a Private equity investor invests in your fund it is only concerned about the exit strategy
Whilst it’s true they will be looking at an exit / next move, PE investors often need to work hard at building the business or turning it around to become successful, therefore the first few years are normally spent focussing on getting the business into a healthy state
Key roles in private equity 🕺🏻
(note, there are many other roles e.g. analysts etc but just focussing on these today):
General partner (GP): The manager of a private equity fund responsible for making investment decisions and managing the fund.
Limited partner (LP): An investor in a private equity fund who provides capital but has limited control over the fund's decisions.
Thank you very much for reading 🙏 if you found this helpful and enjoyed the post, I’d be super grateful if you could hit the ❤️ below - thank you! And if you have topics you’d like me to explain just hit reply and let me know.
DISCLAIMER: None of this is financial advice. Concepts of Finance newsletter is strictly for educational purposes.
Great article! Really well-written and easy to read!
Great article as always! 😀