What is Private Equity?

Published by Thomas Herold in Banking, Corporate Finance, Investments, Real Estate

'Private Equity' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Private Equity refers to an investment capital source that comes from those institutional investors and accredited individual investors who boast high net worth. The goals of these investors are to gain a significant equity ownership in corporations. The partners at these firms raise funds and then manage them to gain higher than average returns for their client shareholders. They commonly pursue this goal via an investment time frame of from four to seven years. Private equity is therefore not for those who require that their investment positions be readily liquid.

Such mega funds are often utilized to buy private companies or to privatize publically listed corporations in order to de-list them from the stock market exchanges in a go private arrangement. Each firm sets its own minimum investment threshold for the fund investors. This ranges depending on the needs of the funds being raised. There are many funds with a minimum $250,000 in smallest investment permitted, while still others look for at least millions of dollars per contributing investor.

The private equity industry has a long and storied history of gaining the best possible talent from the corporate world throughout America. This includes top-delivering CEOs and directors even from Fortune 500 firms as well as the best management consulting and top strategy firms. This is why private equity hiring managers often scout out major corporations, law firms, and accounting companies when they go recruiting for new talent. They require legal experience and accounting skills to provide the many support services that such large enterprises require in order to put together major corporate mergers and acquisitions and to properly advise the management companies on the effective management of their newly acquired portfolios holdings.

There are quite high fees involved with such firms. Typically they receive first a management fee and then a performance fee. This generally amounts to annual management fees at around two percent of all assets under management. The performance fees add up to 20 percent of all gross profits when they sell a company. There can be a great deal of variety in the ways that such firms receive their compensation and incentives to outperform.

It is not hard to understand why private equity has been so successful at recruiting and keeping the very best talent based upon the money they have to offer by way of compensation for performance. Consider that these firms which have a billion dollars’ assets under management would likely have around only two dozen professional investment personnel. They receive $20 million in annual fees just for the assets under management. Add on to this the 20 percent performance fees based on all gross profits, and it is not hard to understand how they generate additional tens of millions of dollars in performance fees for the company.

Middle market level managers and associates generally expect to earn six-figure salaries and bonuses. The vice presidents pull down half a million dollars easily. Principals rake in a cool over million dollars per year in both realized and unrealized compensation.

Given the incredible rewards at stake, it should not come as any surprise that there are a range of types of private equity firms operating today. Many choose the route of passive investing to be strictly financiers. They depend on their appointed management to increase the size and profitability of the firm in which they invest so that the owners will realize generous, outsized returns. Other kinds of these firms choose to be more active investors. They deliver operational support to the management to ensure that they can build up a stronger and more profitable firm which they can then resell or spin off.

These private equity firms pride themselves on their expansive list of contacts and relationships with corporate boards. They leverage these CFO and CEO relationships to help them grow the company revenue as well as to recognize synergies and operational combination opportunities. One of the kingpins of private equity remains Goldman Sachs, the legendary investment bank. They facilitate the biggest deals and concentrate their time on forging acquisitions and mergers that have billions of dollars in notional values. For other smaller investment banking companies, the majority of deals run in the range of from $50 million to $500 million, while lower middle-market transactions vary from $10 million to $50 million in total.

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The term 'Private Equity' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.