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In the field of finance, the term private equity (PE) refers to investment funds, usually
limited partnership A limited partnership (LP) is a form of partnership similar to a general partnership except that while a general partnership must have at least two general partners (GPs), a limited partnership must have at least one GP and at least one limited p ...
s (LP), which buy and restructure financially weak companies that produce goods and provide services. A private-equity fund is both a type of ownership of assets ( financial equity) and is a class of assets (debt securities and equity securities), which function as modes of financial management for operating private companies that are not publicly traded in a
stock exchange A stock exchange, securities exchange, or bourse is an Exchange (organized market), exchange where stockbrokers and stock trader, traders can buy and sell security (finance), securities, such as share (finance), shares of stock, Bond (finance) ...
. Private-equity
capital Capital may refer to: Common uses * Capital city, a municipality of primary status ** List of national capitals, List of national capital cities * Capital letter, an upper-case letter Economics and social sciences * Capital (economics), the dura ...
is invested into a target company either by an investment management company (
private equity firm A private equity firm is an investment management company that provides financial backing and makes investments in the private equity of Startup company, startup or operating companies through a variety of loosely affiliated investment strategie ...
), or by a
venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to start-up company, startups, early-stage, and emerging companies that have been deemed to have high growth poten ...
fund, or by an
angel investor An angel investor (also known as a business angel, informal investor, angel funder, private investor, or seed investor) is an individual who provides capital for a business or businesses Startup company, start-up, usually in exchange for convertibl ...
; each category of investor has specific financial goals, management preferences, and investment strategies for profiting from their investments. Each category of investor provides
working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
to the target company to finance the expansion of the company with the development of new products and services, the restructuring of operations, management, and formal control and ownership of the company. As a financial product, the private-equity fund is a type of ''private capital'' for financing a long-term investment strategy in an illiquid business enterprise. Since the 1980s, the financial press describe "private equity fund" investment as the superficial rebranding of investment management companies who specialized in the
leveraged buyout A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money (Leverage (finance), leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as col ...
of financially weak companies.


Key features

The features of private-equity investment operations: * An investment manager applies the money of investors to fund acquisitions for
hedge fund A hedge fund is a pooled investment fund that trades in relatively Market liquidity, liquid assets and is able to make extensive use of more complex trader (finance), trading, portfolio (finance), portfolio-construction, and risk management techn ...
s,
pension fund A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides pension, retirement income. Pension funds typically have large amounts of money to invest and are the major investors in listed a ...
s, university endowments, and rich people. * Restructuring the target company to sell it for a higher price than paid, and so yield a greater profit for the equity invested, usually by cutting costs for short-term high profits. * Use debt financing ( leverage) to buy a target company; thus, a small increase in the value of the target company — a 20% increase in the price of the company-as-asset — might yield a 100% return on equity invested, if the private equity used to buy the target company was a 20% down-payment and 80% financed debt. Moreover, because debt financing reduces corporate taxes, the interest payments are tax-deductible, and thus increase profits for the investors. * Start-up companies usually produce innovations in products and services, and private-equity firms invest working capital into start-up companies, and create value by reducing costs and aligning the financial interests of the corporate managers with the financial interests of the private-equity shareholders. A greater share of the income of the target company is distributed to the shareholders, and a lesser share of the income is reinvested to the company, i.e. the workers and the manufacturing equipment. Usually, when a private equity firm buys a start-up company, the investors might act like venture capitalists and develop the products and services of the target company in order to achieve a greater share of the market. Moreover, when a private-equity firm buy a large target company, the new corporate management (the private equity investors) might lower morale among the workers, which then results in lower-quality products. * Private-equity investors combine their investment transactions with other investors in a
syndicate A syndicate is a self-organizing group of individuals, companies, corporations or entities formed to transact some specific business, to pursue or promote a shared interest. Etymology The word ''syndicate'' comes from the French language, Frenc ...
, in order to jointly benefit from the diversification of investments among the different types of financial risk; the combination of complementary investor information and financial skill sets; and greater social connections for future investments. * The investment strategies common to private-equity financing include the
leveraged buyout A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money (Leverage (finance), leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as col ...
, distressed securities,
venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to start-up company, startups, early-stage, and emerging companies that have been deemed to have high growth poten ...
, growth capital, and mezzanine capital. In a typical leveraged-buyout transaction, a private-equity firm buys sufficient
stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which owners ...
(shares of ownership) to grant them majority control of a mature company, which is unlike venture capital and growth capital investments, wherein the investors provide working capital to a start-up company, without majority control of the company.


Strategies

The strategies private-equity firms may use are as follows, leveraged buyout being the most common.


Leveraged buyout

Leveraged buyout, LBO, or Buyout refers to a strategy of making equity investments as part of a transaction in which a company, business unit, or business assets is acquired from the current shareholders typically with the use of financial leverage. The companies involved in these transactions are typically mature and generate operating cash flows. Private-equity firms view target companies as either Platform companies, which have sufficient scale and a successful business model to act as a stand-alone entity, or as add-on / tuck-in / bolt-on acquisitions, which would include companies with insufficient scale or other deficits. Leveraged buyouts involve a financial sponsor agreeing to an acquisition without itself committing all the capital required for the acquisition. To do this, the financial sponsor will raise acquisition debt, which looks to the cash flows of the acquisition target to make interest and principal payments. Acquisition debt in an LBO is often non-recourse to the financial sponsor and has no claim on other investments managed by the financial sponsor. Therefore, an LBO transaction's financial structure is particularly attractive to a fund's limited partners, allowing them the benefits of leverage, but limiting the degree of recourse of that leverage. This kind of financing structure leverage benefits an LBO's financial sponsor in two ways: (1) the investor only needs to provide a fraction of the capital for the acquisition, and (2) the returns to the investor will be enhanced, as long as the
return on assets The return on assets (ROA) shows the percentage of how Profit (accounting), profitable a company's assets are in generating revenue. ROA can be computed as below: :\mathrm = \frac This number tells you what the company can do with what it has, '' ...
exceeds the cost of the debt. As a percentage of the purchase price for a leverage buyout target, the amount of debt used to finance a transaction varies according to the financial condition and history of the acquisition target, market conditions, the willingness of lenders to extend credit (both to the LBO's financial sponsors and the company to be acquired) as well as the interest costs and the ability of the company to cover those costs. Historically the debt portion of a LBO will range from 60%–90% of the purchase price. Between 2000–2005 debt averaged between 59.4% and 67.9% of total purchase price for LBOs in the United States.


Simple example of leveraged buyout

A private-equity fund, ABC Capital II, borrows $9bn from a bank (or other lender). To this, it adds $2bn of ''equity'' – money from its own partners and from ''limited partners''. With this $11bn, it buys all the shares of an underperforming company, XYZ Industrial (after ''
due diligence Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care. It can be a l ...
'', i.e. checking the books). It replaces the senior management in XYZ Industrial, with others who set out to streamline it. The workforce is reduced, some assets are sold off, etc. The objective is to increase the valuation of the company for an early sale. The stock market is experiencing a
bull market A market trend is a perceived tendency of financial markets to move in a particular direction over time. Analysts classify these trends as ''secular'' for long time-frames, ''primary'' for medium time-frames, and ''secondary'' for short time-fram ...
, and XYZ Industrial is sold two years after the buy-out for $13bn, yielding a profit of $2bn. The original loan can now be paid off with interest of, say, $0.5bn. The remaining profit of $1.5bn is shared among the partners. Taxation of such gains is at the capital gains tax rates, which in the United States are lower than
ordinary income Under the United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, sta ...
tax rates. Note that part of that profit results from turning the company around, and part results from the general increase in share prices in a buoyant stock market, the latter often being the greater component. Notes: * The lenders (the people who put up the $9bn in the example) can insure against default by syndicating the loan to spread the risk, or by buying
credit default swap A credit default swap (CDS) is a Swap (finance), financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt Default (finance), default (by the debtor) or other credit event. That is, the seller of the ...
s (CDSs) or selling collateralised debt obligations (CDOs) from/to other institutions. * Often the loan/equity ($11bn in the example) is not paid off after the sale, but left on the books of the company (XYZ Industrial) for it to pay off over time. This can be advantageous since the interest is largely off-settable against the profits of the company, thus reducing, or even eliminating, tax. * Most buyout deals are much smaller; the global average purchase in 2013 was $89m, for example. * The target company (XYZ Industrials here) does not have to be floated on the stock market; most buyout exits after 2000 are not IPOs. * Buy-out operations can go wrong and in such cases, the loss is increased by leverage, just as the profit is if all goes well.


Growth capital

Growth capital Growth capital (also called expansion capital and growth equity) is a type of private equity In the field of finance, the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and restructure financial ...
refers to equity investments, most often minority investments, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change of control of the business. Companies that seek growth capital will often do so in order to finance a transformational event in their life cycle. These companies are likely to be more mature than venture capital-funded companies, able to generate revenue and operating profits, but unable to generate sufficient cash to fund major expansions, acquisitions or other investments. Because of this lack of scale, these companies generally can find few alternative conduits to secure capital for growth, so access to growth equity can be critical to pursue necessary facility expansion, sales and marketing initiatives, equipment purchases, and new product development. The primary owner of the company may not be willing to take the financial risk alone. By selling part of the company to private equity, the owner can take out some value and share the risk of growth with partners. Capital can also be used to effect a restructuring of a company's balance sheet, particularly to reduce the amount of leverage (or debt) the company has on its
balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
. A private investment in public equity (PIPE), refer to a form of growth capital investment made into a
publicly traded company A public company is a company A company, abbreviated as co., is a legal entity representing an association of people, whether natural, legal or a mixture of both, with a specific objective. Company members share a common purpose and ...
. PIPE investments are typically made in the form of a
convertible A convertible or cabriolet () is a Car, passenger car that can be driven with or without a roof in place. The methods of retracting and storing the roof vary among eras and manufacturers. A convertible car's design allows an open-air driving ...
or preferred security that is unregistered for a certain period of time. The Registered Direct, or RD, is another common financing vehicle used for growth capital. A registered direct is similar to a PIPE, but is instead sold as a registered security.


Mezzanine capital

Mezzanine capital In finance, mezzanine capital is any subordinated debt or preferred equity Financial instrument, instrument that represents a claim on a company's assets which is senior only to that of the common stock, common shares. Mezzanine financings can be ...
refers to
subordinated debt In finance, subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts if a company falls into liquidation or bankruptcy. Such debt is referred to as 'subordi ...
or preferred equity securities that often represent the most junior portion of a company's
capital structure In corporate finance, capital structure refers to the mix of various forms of external funds, known as Financial_capital, capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is ...
that is senior to the company's common equity. This form of financing is often used by private-equity investors to reduce the amount of equity capital required to finance a leveraged buyout or major expansion. Mezzanine capital, which is often used by smaller companies that are unable to access the high yield market, allows such companies to borrow additional capital beyond the levels that traditional lenders are willing to provide through bank loans. In compensation for the increased risk, mezzanine debt holders require a higher return for their investment than secured or other more senior lenders. Mezzanine securities are often structured with a current income coupon.


Venture capital

Venture capital or VC is a broad subcategory of private equity that refers to equity investments made, typically in less mature companies, for the launch of a seed or startup company, early-stage development, or expansion of a business. Venture investment is most often found in the application of new technology, new marketing concepts and new products that do not have a proven track record or stable revenue streams.Joseph W. Bartlett
"What Is Venture Capital?"
The Encyclopedia of Private Equity. Accessed 20 February 2009
Venture capital is often sub-divided by the stage of development of the company ranging from early-stage capital used for the launch of
startup companies A startup or start-up is a company or project undertaken by an Entrepreneurship, entrepreneur to seek, develop, and validate a scalable business model. While entrepreneurship refers to all new businesses, including self-employment and businesses t ...
to late stage and growth capital that is often used to fund expansion of existing business that are generating revenue but may not yet be profitable or generating cash flow to fund future growth. Entrepreneurs often develop products and ideas that require substantial capital during the formative stages of their companies' life cycles. Many entrepreneurs do not have sufficient funds to finance projects themselves, and they must, therefore, seek outside financing. The venture capitalist's need to deliver high returns to compensate for the risk of these investments makes venture funding an expensive capital source for companies. Being able to secure financing is critical to any business, whether it is a startup seeking venture capital or a mid-sized firm that needs more cash to grow. Venture capital is most suitable for businesses with large up-front
capital requirement A capital requirement (also known as regulatory capital, capital adequacy or capital base) is the amount of capital a bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simulta ...
s which cannot be financed by cheaper alternatives such as
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
. Although venture capital is often most closely associated with fast-growing
technology Technology is the application of knowledge to reach practical goals in a specifiable and Reproducibility, reproducible way. The word ''technology'' may also mean the product of such an endeavor. The use of technology is widely prevalent in me ...
,
healthcare Health care or healthcare is the improvement of health via the preventive healthcare, prevention, diagnosis, therapy, treatment, wiktionary:amelioration, amelioration or cure of disease, illness, injury, and other disability, physical and menta ...
and
biotechnology Biotechnology is the integration of Natural science, natural sciences and Engineering Science, engineering sciences in order to achieve the application of organisms, cells, parts thereof and molecular analogues for products and services. The te ...
fields, venture funding has been used for other more traditional businesses. Investors generally commit to venture capital funds as part of a wider diversified private-equity
portfolio Portfolio may refer to: Objects * Portfolio (briefcase), a type of briefcase Collections * Portfolio (finance), a collection of assets held by an institution or a private individual * Artist's portfolio, a sample of an artist's work or a c ...
, but also to pursue the larger returns the strategy has the potential to offer. However, venture capital funds have produced lower returns for investors over recent years compared to other private-equity fund types, particularly buyout.


Distressed securities

The category of Distressed securities comprises financial strategies for the profitable investment of working capital into the corporate equity and the
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
of financially weak companies. The investment of private-equity capital into distressed securities is realised with two financial strategies: # "Distressed-to-Control" ("Loan-to-Own") investment whereby the investor buys debt securities in hope of acquiring ownership and control of the company's equity after financing the corporate restructuring of the target company; # "Special Situations" ("Turnaround") investment wherein the investor buys debt securities and equity investments, to be used as ''rescue financing'' that will restore the profitability of the financially-weak target company. Moreover, the private-equity investment strategies of
hedge fund A hedge fund is a pooled investment fund that trades in relatively Market liquidity, liquid assets and is able to make extensive use of more complex trader (finance), trading, portfolio (finance), portfolio-construction, and risk management techn ...
s also include actively
trading Trade involves the transfer of goods and services from one person or entity to another, often in exchange for money. Economists refer to a system A system is a group of interacting or interrelated elements that act according to a set of ...
the loans held and the bonds issued by the financially-weak target companies.


Secondaries

Secondary investments refer to investments made in existing private-equity assets. These transactions can involve the sale of
private-equity fund A private equity fund (abbreviated as PE fund) is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity. ...
interests or portfolios of direct investments in
privately held companies A privately held company (or simply a private company) is a company whose shares and related rights or obligations are not offered for public subscription or publicly negotiated in the respective listed markets, but rather the company's stock is ...
through the purchase of these investments from existing
institutional investor An institutional investor is an entity which pools money to purchase Security (finance), securities, real property, and other investment assets or originate loans. Institutional investors include commercial banks, central banks, credit unions, ...
s.The Private Equity Secondaries Market, A complete guide to its structure, operation and performance
The Private Equity Secondaries Market, 2008
By its nature, the private-equity asset class is illiquid, intended to be a long-term investment for
buy and hold Buy and hold, also called position trading, is an investment strategy whereby an investor buys financial asset A financial asset is a non-physical asset whose value is derived from a contractual claim, such as deposit (finance), bank deposits, bon ...
investors. Secondary investments allow institutional investors, particularly those new to the asset class, to invest in private equity from older vintages than would otherwise be available to them. Secondaries also typically experience a different cash flow profile, diminishing the j-curve effect of investing in new private-equity funds. Often investments in secondaries are made through third-party fund vehicle, structured similar to a
fund of funds A "fund of funds" (FOF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which owners ...
although many large institutional investors have purchased private-equity fund interests through secondary transactions. Sellers of private-equity fund investments sell not only the investments in the fund but also their remaining unfunded commitments to the funds.


Other strategies

Other strategies that can be considered private equity or a close adjacent market include: * Real estate: in the context of private equity this will typically refer to the riskier end of the investment spectrum including "value-added" and opportunity funds where the investments often more closely resemble leveraged buyouts than traditional real estate investments. Certain investors in private equity consider real estate to be a separate asset class. *
Infrastructure Infrastructure is the set of facilities and systems that serve a country, city, or other area, and encompasses the services and facilities necessary for its economy, households and firms to function. Infrastructure is composed of public and priv ...
: investments in various public works (e.g., bridges, tunnels, toll roads, airports, public transportation, and other public works) that are made typically as part of a privatization initiative on the part of a government entity. *
Energy In physics, energy (from Ancient Greek: wikt:ἐνέργεια#Ancient_Greek, ἐνέργεια, ''enérgeia'', “activity”) is the physical quantity, quantitative physical property, property that is #Energy transfer, transferred to a phy ...
and Power: investments in a wide variety of companies (rather than assets) engaged in the production and sale of energy, including fuel extraction, manufacturing, refining and distribution (Energy) or companies engaged in the production or transmission of electrical power (Power). *
Merchant bank A merchant bank is historically a bank dealing in commercial loans and investment. In modern British usage it is the same as an investment bank. Merchant banks were the first modern banks and evolved from medieval merchants who traded in commodi ...
ing: negotiated private-equity investment by financial institutions in the unregistered securities of either privately or publicly held companies. *
Fund of funds A "fund of funds" (FOF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which owners ...
: investments made in a fund whose primary activity is investing in other private-equity funds. The fund of funds model is used by investors looking for: :* Diversification but have insufficient capital to diversify their portfolio by themselves :* Access to top-performing funds that are otherwise oversubscribed :* Experience in a particular fund type or strategy before investing directly in funds in that niche :* Exposure to difficult-to-reach and/or emerging markets :* Superior fund selection by high-talent fund of fund managers/teams * Search fund: A search fund is an investment vehicle through which an entrepreneur (called a "searcher") raises funds from investors in order to acquire an existing small business. After an acquisition is made, the entrepreneur takes an operating role in the acquired company, such as CEO and President. * Royalty fund: an investment that purchases a consistent revenue stream deriving from the payment of royalties. One growing subset of this category is the healthcare royalty fund, in which a private-equity fund manager purchases a royalty stream paid by a pharmaceutical company to a drug patent holder. The drug patent holder can be another company, an individual inventor, or some sort of institution, such as a research university. As well as this to compensate for private equities not being traded on the public market, a
private equity secondary market In finance, the private-equity secondary market (also often called private-equity secondaries or secondaries) refers to the buying and selling of pre-existing investor commitments to private equity, private-equity and other alternative investment ...
has formed, where private equity investors purchase securities and assets from other private equity investors.


History and development


Early history and the development of venture capital

The seeds of the US private-equity industry were planted in 1946 with the founding of two venture capital firms: American Research and Development Corporation (ARDC) and J.H. Whitney & Company. Before World War II, venture capital investments (originally known as "development capital") were primarily the domain of wealthy individuals and families. In 1901 J.P. Morgan arguably managed the first leveraged buyout of the
Carnegie Steel Company Carnegie Steel Company was a steel-producing company primarily created by Andrew Carnegie and several close associates to manage businesses at steel mills in the Pittsburgh, Pennsylvania, Pittsburgh, Pennsylvania area in the late 19th centur ...
using private equity. Modern era private equity, however, is credited to Georges Doriot, the "father of venture capitalism" with the founding of ARDC and founder of
INSEAD INSEAD, a contraction of "Institut Européen d'Administration des Affaires" () is a non-profit business school that maintains campuses in Europe ( Fontainebleau, France France (), officially the French Republic ( ), is a country pri ...
, with capital raised from institutional investors, to encourage private sector investments in businesses run by soldiers who were returning from World War II. ARDC is credited with the first major venture capital success story when its 1957 investment of $70,000 in
Digital Equipment Corporation Digital Equipment Corporation (DEC ), using the trademark Digital, was a major American company in the computer industry from the 1960s to the 1990s. The company was co-founded by Ken Olsen and Harlan Anderson in 1957. Olsen was president until ...
(DEC) would be valued at over $355 million after the company's initial public offering in 1968 (a return of over 5,000 times its investment and an annualized rate of return of 101%). It is commonly noted that the first venture-backed startup is
Fairchild Semiconductor Fairchild Semiconductor International, Inc. was an American semiconductor company based in San Jose, California. Founded in 1957 as a division of Fairchild Camera and Instrument, it became a pioneer in the manufacturing of transistors and of ...
, which produced the first commercially practicable integrated circuit, funded in 1959 by what would later become Venrock Associates.


Origins of the leveraged buyout

The first leveraged buyout may have been the purchase by McLean Industries, Inc. of Pan-Atlantic Steamship Company in January 1955 and
Waterman Steamship Corporation Waterman is an American deep sea ocean carrier, specializing in liner services and time charter contracts. It is owned by SEACOR Holdings. History Waterman was founded in 1919 in Mobile, Alabama by John Barnett Waterman, Henry Crawford Slaton, ...
in May 1955 Under the terms of that transaction, McLean borrowed $42 million and raised an additional $7 million through an issue of
preferred stock Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt inst ...
. When the deal closed, $20 million of Waterman cash and assets were used to retire $20 million of the loan debt. Lewis Cullman's acquisition of Orkin Exterminating Company in 1964 is often cited as the first leveraged buyout. Similar to the approach employed in the McLean transaction, the use of
publicly traded A public company is a company whose ownership is organized via shares of share capital, stock which are intended to be freely traded on a stock exchange or in Over-the-counter (finance), over-the-counter markets. A public (publicly traded) comp ...
holding companies as investment vehicles to acquire portfolios of investments in corporate assets was a relatively new trend in the 1960s popularized by the likes of
Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway. He is one of the most successful investors in the world and has a net ...
(
Berkshire Hathaway Berkshire Hathaway Inc. () is an American Multinational corporation, multinational conglomerate (company), conglomerate holding company headquartered in Omaha, Nebraska, United States. Its main business and source of capital is insurance, from ...
) and
Victor Posner Victor Posner (September 18, 1918 – February 11, 2002) was an American businessman. He was one of the highest-paid business corporate officer, executives of his generation. He was a pioneer of the leveraged buyout and became notorious ...
( DWG Corporation) and later adopted by
Nelson Peltz Nelson Peltz (born June 24, 1942) is an American billionaire businessman and investor. He is a founding partner, together with Peter W. May and Edward P. Garden, of Trian Fund Management, an alternative investment management fund based in New Yor ...
(
Triarc The Wendy's Company is an American holding company for the major fast food chain Wendy's. Its headquarters are in Dublin, Ohio. The company's principal subsidiary, Wendy's International, is the franchising, franchisor of Wendy's restaurants. ...
), Saul Steinberg (Reliance Insurance) and
Gerry Schwartz Gerald W. Schwartz, Order of Canada, OC (born 1941) is the founder, chairman and CEO of Onex Corporation. Schwartz has a net worth of US$1.5 billion, according to Forbes. Early life and career Schwartz was born in Winnipeg, Manitoba. He graduate ...
(
Onex Corporation Onex Corporation is an investment manager founded in 1984. The firm manages capital on behalf of Onex shareholders, institutional investors and high net worth clients around the world. As of September 30, 2022, Onex had approximately US$47.2 ...
). These investment vehicles would utilize a number of the same tactics and target the same type of companies as more traditional leveraged buyouts and in many ways could be considered a forerunner of the later private-equity firms. Posner is often credited with coining the term "
leveraged buyout A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money (Leverage (finance), leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as col ...
" or "LBO". The leveraged buyout boom of the 1980s was conceived by a number of corporate financiers, most notably Jerome Kohlberg Jr. and later his protégé Henry Kravis. Working for
Bear Stearns The Bear Stearns Companies, Inc. was a New York-based global investment bank, securities trading and brokerage firm that failed in 2008 as part of the global financial crisis and recession, and was subsequently sold to JPMorgan Chase. The c ...
at the time, Kohlberg and Kravis along with Kravis' cousin George Roberts began a series of what they described as "bootstrap" investments. Many of these companies lacked a viable or attractive exit for their founders as they were too small to be taken public and the founders were reluctant to sell out to competitors and so a sale to a financial buyer could prove attractive. In the following years the three
Bear Stearns The Bear Stearns Companies, Inc. was a New York-based global investment bank, securities trading and brokerage firm that failed in 2008 as part of the global financial crisis and recession, and was subsequently sold to JPMorgan Chase. The c ...
bankers would complete a series of buyouts including Stern Metals (1965), Incom (a division of Rockwood International, 1971), Cobblers Industries (1971), and Boren Clay (1973) as well as Thompson Wire, Eagle Motors and Barrows through their investment in Stern Metals. By 1976, tensions had built up between
Bear Stearns The Bear Stearns Companies, Inc. was a New York-based global investment bank, securities trading and brokerage firm that failed in 2008 as part of the global financial crisis and recession, and was subsequently sold to JPMorgan Chase. The c ...
and Kohlberg, Kravis and Roberts leading to their departure and the formation of
Kohlberg Kravis Roberts KKR & Co. Inc., also known as Kohlberg Kravis Roberts & Co., is an American global investment company that manages multiple alternative asset classes, including private equity, energy, infrastructure, real estate, credit, and, through its strateg ...
in that year.


Private equity in the 1980s

In January 1982, former
United States Secretary of the Treasury The United States secretary of the treasury is the head of the United States Department of the Treasury, and is the chief financial officer of the federal government of the United States The federal government of the United States ( ...
William E. Simon and a group of investors acquired
Gibson Greetings American Greetings Corporation is a privately owned American company and is the world's second largest greeting card producer behind Hallmark Cards. Based in Westlake, Ohio, a suburb of Cleveland, Ohio, Cleveland, the company sells paper greeting ...
, a producer of greeting cards, for $80 million, of which only $1 million was rumored to have been contributed by the investors. By mid-1983, just sixteen months after the original deal, Gibson completed a $290 million IPO and Simon made approximately $66 million. The success of the Gibson Greetings investment attracted the attention of the wider media to the nascent boom in leveraged buyouts. Between 1979 and 1989, it was estimated that there were over 2,000 leveraged buyouts valued in excess of $250 million. During the 1980s, constituencies within acquired companies and the media ascribed the "
corporate raid In business, a corporate raid is the process of buying a large stake in a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal e ...
" label to many private-equity investments, particularly those that featured a
hostile takeover In business, a takeover is the purchase of one company (law), company (the ''target'') by another (the ''acquirer'' or ''bidder''). In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in ...
of the company, perceived
asset stripping Asset stripping is a term used to refer to the practice of selling off a company's assets in order to improve returns for equity investors. In many cases where the term is used, a financial investor, referred to as a 'corporate raider', takeover, t ...
, major layoffs or other significant corporate restructuring activities. Among the most notable investors to be labeled corporate raiders in the 1980s included
Carl Icahn Carl Celian Icahn (; born February 16, 1936) is an American financier. He is the founder and controlling shareholder of Icahn Enterprises, a public company and diversified conglomerate holding company based in Sunny Isles Beach. Icahn takes la ...
,
Victor Posner Victor Posner (September 18, 1918 – February 11, 2002) was an American businessman. He was one of the highest-paid business corporate officer, executives of his generation. He was a pioneer of the leveraged buyout and became notorious ...
,
Nelson Peltz Nelson Peltz (born June 24, 1942) is an American billionaire businessman and investor. He is a founding partner, together with Peter W. May and Edward P. Garden, of Trian Fund Management, an alternative investment management fund based in New Yor ...
, Robert M. Bass, T. Boone Pickens, Harold Clark Simmons,
Kirk Kerkorian Kerkor Kerkorian ( hy, Գրիգոր Գրիգորեան; June 6, 1917 – June 15, 2015) was an American businessman, investor, and philanthropist. He was the president and CEO of Tracinda Corporation, his private holding company based in Beverl ...
, Sir James Goldsmith, Saul Steinberg and Asher Edelman.
Carl Icahn Carl Celian Icahn (; born February 16, 1936) is an American financier. He is the founder and controlling shareholder of Icahn Enterprises, a public company and diversified conglomerate holding company based in Sunny Isles Beach. Icahn takes la ...
developed a reputation as a ruthless
corporate raid In business, a corporate raid is the process of buying a large stake in a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal e ...
er after his hostile takeover of
TWA Trans World Airlines (TWA) was a major American airline which operated from 1930 until 2001. It was formed as Transcontinental & Western Air to operate a route from New York City to Los Angeles via St. Louis, Kansas City, and other stops, with F ...
in 1985.10 Questions for Carl Icahn
by Barbara Kiviat,
TIME magazine ''Time'' (stylized in all caps) is an American news magazine based in New York City New York, often called New York City or NYC, is the List of United States cities by population, most populous city in the Unite ...
, 15 February 2007
Many of the corporate raiders were onetime clients of
Michael Milken Michael Robert Milken (born July 4, 1946) is an American financier. He is known for his role in the development of the market for high-yield bonds ("junk bonds"), and his conviction and sentence following a guilty plea on felony charges for vio ...
, whose investment banking firm,
Drexel Burnham Lambert Drexel Burnham Lambert was an American multinational investment banking, investment bank that was forced into bankruptcy in 1990 due to its involvement in illegal activities in the junk bond market, driven by senior executive Michael Milken. At ...
helped raise blind pools of capital with which corporate raiders could make a legitimate attempt to take over a company and provided
high-yield debt In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a Bond (finance), bond that is rated below investment grade by credit rating agencies. These bonds have a higher risk of default (finance), defau ...
("junk bonds") financing of the buyouts. One of the final major buyouts of the 1980s proved to be its most ambitious and marked both a high-water mark and a sign of the beginning of the end of the boom. In 1989, KKR (Kohlberg Kravis Roberts) closed in on a $31.1 billion takeover of RJR Nabisco. It was, at that time and for over 17 years, the largest leveraged buyout in history. The event was chronicled in the book (and later the movie), '' Barbarians at the Gate: The Fall of RJR Nabisco''. KKR would eventually prevail in acquiring RJR Nabisco at $109 per share, marking a dramatic increase from the original announcement that Shearson Lehman Hutton would take RJR Nabisco private at $75 per share. A fierce series of negotiations and horse-trading ensued which pitted KKR against Shearson and later Forstmann Little & Co. Many of the major banking players of the day, including
Morgan Stanley Morgan Stanley is an American multinational investment management and financial services company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in more than 41 countries and more than 75,000 employees, the fir ...
,
Goldman Sachs Goldman Sachs () is an American multinational Investment banking, investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Wars ...
,
Salomon Brothers Salomon Brothers, Inc., was an American multinational bulge bracket investment bank headquartered in New York City, New York. It was one of the five List of investment banks, largest investment banking enterprises in the United States and the mo ...
, and
Merrill Lynch Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investment banki ...
were actively involved in advising and financing the parties. After Shearson's original bid, KKR quickly introduced a tender offer to obtain RJR Nabisco for $90 per share—a price that enabled it to proceed without the approval of RJR Nabisco's management. RJR's management team, working with Shearson and Salomon Brothers, submitted a bid of $112, a figure they felt certain would enable them to outflank any response by Kravis's team. KKR's final bid of $109, while a lower dollar figure, was ultimately accepted by the board of directors of RJR Nabisco. At $31.1 billion of transaction value, RJR Nabisco was by far the largest leveraged buyouts in history. In 2006 and 2007, a number of leveraged buyout transactions were completed that for the first time surpassed the RJR Nabisco leveraged buyout in terms of nominal purchase price. However, adjusted for inflation, none of the leveraged buyouts of the 2006–2007 period would surpass RJR Nabisco. By the end of the 1980s the excesses of the buyout market were beginning to show, with the bankruptcy of several large buyouts including
Robert Campeau Robert Joseph Antoine Campeau (August 3, 1923 June 12, 2017) was a Canadian financier and real estate developer. Starting from a single house constructed in 1940 in the Alta Vista neighbourhood of Ottawa, Ontario, Campeau built a large land dev ...
's 1988 buyout of
Federated Department Stores Macy's, Inc. (originally Federated Department Stores, Inc.) is an American Conglomerate (company), conglomerate holding company. Upon its establishment, Federated held ownership of the regional department store chains Abraham & Straus, Lazarus ( ...
, the 1986 buyout of the Revco drug stores, Walter Industries, FEB Trucking and Eaton Leonard. Additionally, the RJR Nabisco deal was showing signs of strain, leading to a recapitalization in 1990 that involved the contribution of $1.7 billion of new equity from KKR. In the end, KKR lost $700 million on RJR. Drexel reached an agreement with the government in which it pleaded ''
nolo contendere ' is a legal term that comes from the Latin phrase for "I do not wish to contend". It is also referred to as a plea of no contest or no defense. In criminal Trial (law), trials in certain United States jurisdictions, it is a plea where the def ...
'' (no contest) to six felonies – three counts of stock parking and three counts of
stock manipulation In economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the be ...
. It also agreed to pay a fine of $650 million – at the time, the largest fine ever levied under securities laws. Milken left the firm after his own indictment in March 1989.New Street Capital Inc.
– Company Profile, Information, Business Description, History, Background Information on New Street Capital Inc. at ReferenceForBusiness.com
On 13 February 1990 after being advised by United States Secretary of the Treasury Nicholas F. Brady, the U.S. Securities and Exchange Commission (SEC), the
New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City New York, often called New York City or NYC, is the List o ...
and the
Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
, Drexel Burnham Lambert officially filed for
Chapter 11 Chapter 11 of the United States Bankruptcy Code (Title 11 of the United States Code Title 11 of the United States Code, also known as the United States Bankruptcy Code, is the source of Bankruptcy in the United States, bankruptcy law in the Uni ...
bankruptcy protection.'' Den of Thieves''. Stewart, J. B. New York: Simon & Schuster, 1991. .


Age of the mega-buyout: 2005–2007

The combination of decreasing interest rates, loosening lending standards and regulatory changes for publicly traded companies (specifically the
Sarbanes–Oxley Act The Sarbanes–Oxley Act of 2002 is a United States federal law that mandates certain practices in financial record keeping and reporting for corporations. The act, (), also known as the "Public Company Accounting Reform and Investor Protecti ...
) would set the stage for the largest boom private equity had seen. Marked by the buyout of Dex Media in 2002, large multibillion-dollar U.S. buyouts could once again obtain significant high yield debt financing and larger transactions could be completed. By 2004 and 2005, major buyouts were once again becoming common, including the acquisitions of
Toys "R" Us Toys "R" Us is an American toy, clothing, and baby product retailer owned by Tru Kids (doing business as Tru Kids Brands) and various others. The company was founded in 1957; its first store was built in April 1948, with its headquarters loca ...
,
The Hertz Corporation The Hertz Corporation is an American car rental A car rental, hire car or car hire agency is a company that renting, rents automobiles for short periods of time to the public, generally ranging from a few hours to a few weeks. It is often or ...
,
Metro-Goldwyn-Mayer Metro-Goldwyn-Mayer Studios Inc., also known as Metro-Goldwyn-Mayer Pictures and abbreviated as MGM, is an American film, television production, distribution and media company owned by amazon (company), Amazon through MGM Holdings, founded o ...
and SunGard in 2005. As 2006 began, new "largest buyout" records were set and surpassed several times with nine of the top ten buyouts at the end of 2007 having been announced in an 18-month window from the beginning of 2006 through the middle of 2007. In 2006, private-equity firms bought 654 U.S. companies for $375 billion, representing 18 times the level of transactions closed in 2003. Additionally, U.S.-based private-equity firms raised $215.4 billion in investor commitments to 322 funds, surpassing the previous record set in 2000 by 22% and 33% higher than the 2005 fundraising total The following year, despite the onset of turmoil in the credit markets in the summer, saw yet another record year of fundraising with $302 billion of investor commitments to 415 funds Among the mega-buyouts completed during the 2006 to 2007 boom were:
EQ Office EQ Office is a real estate investing, real estate investment investment company, company that owns 80 office properties comprising 40 million square feet. The company is owned by funds managed by The Blackstone Group. The company was formerly kno ...
, HCA,
Alliance Boots Alliance Boots GmbH was a multinational pharmacy-led health and beauty group with corporate headquarters in Bern Bern () or Berne; in other Swiss languages, gsw, Bärn ; frp, Bèrna ; it, Berna ; rm, Berna is the ''de facto'' Capital city, ...
and TXU. In July 2007, the turmoil that had been affecting the mortgage markets, spilled over into the leveraged finance and high-yield debt markets. The markets had been highly robust during the first six months of 2007, with highly issuer friendly developments including PIK and PIK Toggle (interest is "''P''ayable ''I''n ''K''ind") and covenant light debt widely available to finance large leveraged buyouts. July and August saw a notable slowdown in issuance levels in the high yield and leveraged loan markets with few issuers accessing the market. Uncertain market conditions led to a significant widening of yield spreads, which coupled with the typical summer slowdown led many companies and investment banks to put their plans to issue debt on hold until the autumn. However, the expected rebound in the market after 1 May 2007 did not materialize, and the lack of market confidence prevented deals from pricing. By the end of September, the full extent of the credit situation became obvious as major lenders including
Citigroup Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
and
UBS AG UBS Group AG is a multinational Investment banking, investment bank and financial services company founded and based in Switzerland. Co-headquartered in the cities of Zürich and Basel, it maintains a presence in all major financial centres ...
announced major writedowns due to credit losses. The leveraged finance markets came to a near standstill during a week in 2007. As 2008 began, lending standards tightened and the era of "mega-buyouts" came to an end. Nevertheless, private equity continues to be a large and active asset class and the private-equity firms, with hundreds of billions of dollars of committed capital from investors are looking to deploy capital in new and different transactions. As a result of the global financial crisis, private equity has become subject to increased regulation in Europe and is now subject, among other things, to rules preventing asset stripping of portfolio companies and requiring the notification and disclosure of information in connection with buy-out activity. Staying private for longer From 2010 to 2014 KKR, Carlyle,
Apollo Apollo, grc, Ἀπόλλωνος, Apóllōnos, label=genitive , ; , grc-dor, Ἀπέλλων, Apéllōn, ; grc, Ἀπείλων, Apeílōn, label=Arcadocypriot Greek Arcadocypriot, or southern Achaeans (tribe), Achaean, was an ancient ...
and
Ares Ares (; grc, Ἄρης, ''Árēs'' ) is the List of Greek mythological figures, Greek god of war god, war and courage. He is one of the Twelve Olympians, and the son of Zeus and Hera. The Greeks were ambivalent towards him. He embodies the p ...
went public. Starting from 2018 these companies converted from partnerships into corporations with more shareholder rights and the inclusion in stock indices and mutual fund portfolios. But with the increased availability and scope of funding provided by private markets, many companies are staying private simply because they can. McKinsey & Company reports in its Global Private Markets Review 2018 that global private market fundraising increased by $28.2 billion from 2017, for a total of $748 billion in 2018. Thus, given the abundance of private capital available, companies no longer require public markets for sufficient funding. Benefits may include avoiding the cost of an IPO, maintaining more control of the company, and having the 'legroom' to think long-term rather than focus on short-term or quarterly figures. A new phenomenon in the Twenties are regulated platforms which fractionalise the assets making investment sizes of $10,000 or less possible.


Investments in private equity

Although the capital for private equity originally came from individual investors or corporations, in the 1970s, private equity became an asset class in which various
institutional investor An institutional investor is an entity which pools money to purchase Security (finance), securities, real property, and other investment assets or originate loans. Institutional investors include commercial banks, central banks, credit unions, ...
s allocated capital in the hopes of achieving risk-adjusted returns that exceed those possible in the public equity markets. In the 1980s, insurers were major private-equity investors. Later, public pension funds and university and other endowments became more significant sources of capital. For most institutional investors, private-equity investments are made as part of a broad asset allocation that includes traditional assets (e.g., public equity and bonds) and other alternative assets (e.g.,
hedge fund A hedge fund is a pooled investment fund that trades in relatively Market liquidity, liquid assets and is able to make extensive use of more complex trader (finance), trading, portfolio (finance), portfolio-construction, and risk management techn ...
s, real estate,
commodities In economics, a commodity is an economic goods, good, usually a resource, that has full or substantial fungibility: that is, the Market (economics), market treats instances of the good as equivalent or nearly so with no regard to who Production ...
).


Investor categories

US, Canadian and European public and private pension schemes have invested in the asset class since the early 1980s to diversify away from their core holdings (public equity and fixed income).M. Nicolas J. Firzli
‘The New Drivers of Pension Investment in Private Equity’, Revue Analyse Financière, Q3 2014 – Issue N°52
/ref> Today pension investment in private equity accounts for more than a third of all monies allocated to the asset class, ahead of other institutional investors such as insurance companies, endowments, and sovereign wealth funds.


Direct versus indirect investment

Most institutional investors do not invest directly in
privately held companies A privately held company (or simply a private company) is a company whose shares and related rights or obligations are not offered for public subscription or publicly negotiated in the respective listed markets, but rather the company's stock is ...
, lacking the expertise and resources necessary to structure and monitor the investment. Instead,
institutional investor An institutional investor is an entity which pools money to purchase Security (finance), securities, real property, and other investment assets or originate loans. Institutional investors include commercial banks, central banks, credit unions, ...
s will invest indirectly through a
private-equity fund A private equity fund (abbreviated as PE fund) is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity. ...
. Certain
institutional investor An institutional investor is an entity which pools money to purchase Security (finance), securities, real property, and other investment assets or originate loans. Institutional investors include commercial banks, central banks, credit unions, ...
s have the scale necessary to develop a diversified portfolio of private-equity funds themselves, while others will invest through a
fund of funds A "fund of funds" (FOF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which owners ...
to allow a portfolio more diversified than one a single investor could construct.


Investment timescales

Returns on private-equity investments are created through one or a combination of three factors that include: debt repayment or cash accumulation through cash flows from operations, operational improvements that increase earnings over the life of the investment and multiple expansion, selling the business for a higher price than was originally paid. A key component of private equity as an asset class for institutional investors is that investments are typically realized after some period of time, which will vary depending on the investment strategy. Private-equity investment returns are typically realized through one of the following avenues: * an ''
initial public offering An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also to retail (individual) investors. An IPO is typically Underwriting, underwritten by one or mo ...
'' (''IPO'') – shares of the company are offered to the public, typically providing a partial immediate realization to the financial sponsor as well as a public market into which it can later sell additional shares; * a ''
merger Mergers and acquisitions (M&A) are business transactions in which the ownership of Company, companies, other business organizations, or their operating units are transferred to or Consolidation (business), consolidated with another company or b ...
'' or '' acquisition'' – the company is sold for either cash or shares in another company; * a ''recapitalization'' – cash is distributed to the shareholders (in this case the financial sponsor) and its
private-equity fund A private equity fund (abbreviated as PE fund) is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity. ...
s either from cash flow generated by the company or through raising debt or other securities to fund the distribution. Large institutional asset owners such as pension funds (with typically long-dated liabilities), insurance companies, sovereign wealth and national reserve funds have a generally low likelihood of facing liquidity shocks in the medium term, and thus can afford the required long holding periods characteristic of private-equity investment. The median horizon for a LBO transaction is eight years.


Liquidity in the private-equity market

The private-equity secondary market (also often called private-equity secondaries) refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds. Sellers of private-equity investments sell not only the investments in the fund but also their remaining unfunded commitments to the funds. By its nature, the private-equity asset class is illiquid, intended to be a long-term investment for buy-and-hold investors. For the vast majority of private-equity investments, there is no listed public market; however, there is a robust and maturing secondary market available for sellers of private-equity assets. Increasingly, secondaries are considered a distinct asset class with a cash flow profile that is not correlated with other private-equity investments. As a result, investors are allocating capital to secondary investments to diversify their private-equity programs. Driven by strong demand for private-equity exposure, a significant amount of capital has been committed to secondary investments from investors looking to increase and diversify their private-equity exposure. Investors seeking access to private equity have been restricted to investments with structural impediments such as long lock-up periods, lack of transparency, unlimited leverage, concentrated holdings of illiquid securities and high investment minimums. Secondary transactions can be generally split into two basic categories: ; Sale of limited-partnership interests : The most common secondary transaction, this category includes the sale of an investor's interest in a private-equity fund or portfolio of interests in various funds through the transfer of the investor's limited-partnership interest in the fund(s). Nearly all types of private-equity funds (e.g., including buyout, growth equity, venture capital, mezzanine, distressed and real estate) can be sold in the secondary market. The transfer of the limited partnership interest typically will allow the investor to receive some liquidity for the funded investments as well as a release from any remaining unfunded obligations to the fund. ; Sale of direct interests, secondary directs or synthetic secondaries : This category refers to the sale of portfolios of direct investments in operating companies, rather than limited partnership interests in investment funds. These portfolios historically have originated from either corporate development programs or large financial institutions.


Private-equity firms

According to the 2017 ranking created by industry magazine Private Equity International (published by PEI Media called the PEI 300), the largest private-equity firm in the world today was The Blackstone Group based on the amount of private-equity direct-investment capital raised over a five-year window. As ranked by the PEI 300, the 10 largest private-equity firms in the world in 2017 were: #
The Blackstone Group Blackstone Inc. is an American alternative investment management company based in New York City. Blackstone's private equity business has been one of the largest investors in leveraged buyouts in the last three decades, while its real estate bu ...
#
Kohlberg Kravis Roberts KKR & Co. Inc., also known as Kohlberg Kravis Roberts & Co., is an American global investment company that manages multiple alternative asset classes, including private equity, energy, infrastructure, real estate, credit, and, through its strateg ...
#
The Carlyle Group The Carlyle Group is a multinational private equity firm, private equity, alternative asset management and financial services corporation based in the United States with $376 billion of assets under management. It specializes in private equity, ...
#
TPG Capital TPG Inc., previously known as Texas Pacific Group and TPG Capital, is an American investment company based in Fort Worth, Texas. The private equity firm is focused on leveraged buyouts and growth capital. TPG manages investment funds in growth c ...
#
Sequoia Capital Sequoia Capital is an American venture capital firm. The firm is headquartered in Menlo Park, California, and specializes in seed stage, early stage, and growth stage investments in private companies across technology sectors. , Sequoia's total a ...
#
Warburg Pincus Warburg Pincus LLC is a global private equity firm, headquartered in New York, with offices in the United States, Europe, Brazil, China, Southeast Asia and India. Warburg has been a private equity investor since 1966. The firm currently has over ...
# Foxhog Ventures Corp. # Tigar Global # Advent International Corporation #
Apollo Global Management Apollo Global Management, Inc. is an American global private-equity firm. It provides investment management and invests in credit, private equity, and real assets. As of March 31, 2022, the company had $512 billion of assets under management, i ...
# EnCap Investments #
Neuberger Berman Neuberger Berman Group LLC is a private, independent, employee-owned investment management firm. The firm manages equities, fixed income, private equity and hedge fund portfolios for global institutional investors, advisors and high-net-worth in ...
#
CVC Capital Partners CVC Capital Partners is a Luxembourg-based France, French private equity and investment advisory firm with approximately US$133 billion of assets under management and approximately €157 billion in secured commitments since inception across Amer ...
# DCF Ventures Because private-equity firms are continuously in the process of raising, investing and distributing their
private-equity fund A private equity fund (abbreviated as PE fund) is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity. ...
s, capital raised can often be the easiest to measure. Other metrics can include the total value of companies purchased by a firm or an estimate of the size of a firm's active portfolio plus capital available for new investments. As with any list that focuses on size, the list does not provide any indication as to relative investment performance of these funds or managers. Preqin, an independent data provider, ranks the 25 largest private-equity investment managers. Among the larger firms in the 2017 ranking were
AlpInvest Partners AlpInvest Partners is a Dutch private equity asset management, asset manager with over $47 billion of assets under management as of September 30, 2017. The firm invests on behalf of a broad range of institutional investors from North America, Asi ...
, Ardian (formerly AXA Private Equity), AIG Investments, and
Goldman Sachs Capital Partners Goldman Sachs Capital Partners is the private equity arm of Goldman Sachs, focused on leveraged buyout and growth capital investments globally. The group, which is based in New York City, was founded in 1986. As of 2019, GS Capital Partners had r ...
. Invest Europe publishes a yearbook which analyses industry trends derived from data disclosed by over 1,300 European private-equity funds. Finally, websites such as AskIvy.net provide lists of London-based private-equity firms.


Versus hedge funds

The investment strategies of private-equity firms differ from those of
hedge fund A hedge fund is a pooled investment fund that trades in relatively Market liquidity, liquid assets and is able to make extensive use of more complex trader (finance), trading, portfolio (finance), portfolio-construction, and risk management techn ...
s. Typically, private-equity investment groups are geared towards long-hold, multiple-year investment strategies in illiquid assets (whole companies, large-scale real estate projects, or other tangibles not easily converted to cash) where they have more control and influence over operations or asset management to influence their long-term returns. Hedge funds usually focus on short or medium term liquid securities which are more quickly convertible to cash, and they do not have direct control over the business or asset in which they are investing. Both private-equity firms and hedge funds often specialize in specific types of investments and transactions. Private-equity specialization is usually in specific industry sector asset management while hedge fund specialization is in industry sector risk capital management. Private-equity strategies can include wholesale purchase of a privately held company or set of assets, mezzanine financing for startup projects, growth capital investments in existing businesses or
leveraged buyout A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money (Leverage (finance), leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as col ...
of a publicly held asset converting it to private control. Finally, private-equity firms only take long positions, for
short selling In finance, being short in an asset means investing in such a way that the investor will profit if the Market value, value of the asset falls. This is the opposite of a more conventional "Long (finance), long" Position (finance), position, wh ...
is not possible in this asset class.


Private-equity funds

Private-equity fundraising refers to the action of private-equity firms seeking capital from investors for their funds. Typically an investor will invest in a specific fund managed by a firm, becoming a limited partner in the fund, rather than an investor in the firm itself. As a result, an investor will only benefit from investments made by a firm where the investment is made from the specific fund in which it has invested. *
Fund of funds A "fund of funds" (FOF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in stock In finance, stock (also capital stock) consists of all the Share (finance), shares by which owners ...
. These are private-equity funds that invest in other private-equity funds in order to provide investors with a lower risk product through exposure to a large number of vehicles often of different type and regional focus. Fund of funds accounted for 14% of global commitments made to private-equity funds in 2006. * Individuals with substantial
net worth Net worth is the value of all the non-financial and financial assets owned by an individual or institution minus the value of all its outstanding Liability (financial accounting), liabilities. Since financial assets minus outstanding liabilitie ...
. Substantial net worth is often required of investors by the law, since private-equity funds are generally less regulated than ordinary
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase Security (finance), securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe ...
s. For example, in the US, most funds require potential investors to qualify as
accredited investor An accredited or sophisticated investor is an investor with a special status under financial regulation laws. The definition of an accredited investor (if any), and the consequences of being classified as such, vary between countries. Generally, acc ...
s, which requires $1 million of net worth, $200,000 of individual income, or $300,000 of joint income (with spouse) for two documented years and an expectation that such income level will continue. As fundraising has grown over the past few years, so too has the number of investors in the average fund. In 2004, there were 26 investors in the average private-equity fund, this figure has now grown to 42 according to Preqin ltd. (formerly known as Private Equity Intelligence). The managers of private-equity funds will also invest in their own vehicles, typically providing between 1–5% of the overall capital. Often private-equity fund managers will employ the services of external fundraising teams known as placement agents in order to raise capital for their vehicles. The use of placement agents has grown over the past few years, with 40% of funds closed in 2006 employing their services, according to Preqin ltd. Placement agents will approach potential investors on behalf of the fund manager, and will typically take a fee of around 1% of the commitments that they are able to garner. The amount of time that a private-equity firm spends raising capital varies depending on the level of interest among investors, which is defined by current market conditions and also the track record of previous funds raised by the firm in question. Firms can spend as little as one or two months raising capital when they are able to reach the target that they set for their funds relatively easily, often through gaining commitments from existing investors in their previous funds, or where strong past performance leads to strong levels of investor interest. Other managers may find fundraising taking considerably longer, with managers of less popular fund types finding the fundraising process more tough. It can take up to two years to raise capital, although the majority of fund managers will complete fundraising within nine months to fifteen months. Once a fund has reached its fundraising target, it will have a final close. After this point it is not normally possible for new investors to invest in the fund, unless they were to purchase an interest in the fund on the secondary market.


Size of the industry

The state of the industry around the end of 2011 was as follows.Private Equity Report, 2012
. TheCityUK.
Private-equity assets under management probably exceeded $2 trillion at the end of March 2012, and funds available for investment totaled $949bn (about 47% of overall assets under management). Approximately $246bn of private equity was invested globally in 2011, down 6% on the previous year and around two-thirds below the peak activity in 2006 and 2007. Following on from a strong start, deal activity slowed in the second half of 2011 due to concerns over the global economy and sovereign debt crisis in Europe. There was $93bn in investments during the first half of this year as the slowdown persisted into 2012. This was down a quarter on the same period in the previous year. Private-equity backed buyouts generated some 6.9% of global M&A volume in 2011 and 5.9% in the first half of 2012. This was down on 7.4% in 2010 and well below the all-time high of 21% in 2006. Global exit activity totalled $252bn in 2011, practically unchanged from the previous year, but well up on 2008 and 2009 as private-equity firms sought to take advantage of improved market conditions at the start of the year to realise investments. Exit activity however, has lost momentum following a peak of $113bn in the second quarter of 2011. TheCityUK estimates total exit activity of some $100bn in the first half of 2012, well down on the same period in the previous year. The fund raising environment remained stable for the third year running in 2011 with $270bn in new funds raised, slightly down on the previous year's total. Around $130bn in funds was raised in the first half of 2012, down around a fifth on the first half of 2011. The average time for funds to achieve a final close fell to 16.7 months in the first half of 2012, from 18.5 months in 2011. Private-equity funds available for investment ("dry powder") totalled $949bn at the end of q1-2012, down around 6% on the previous year. Including unrealised funds in existing investments, private-equity funds under management probably totalled over $2.0 trillion. Public pensions are a major source of capital for private-equity funds. Increasingly, sovereign wealth funds are growing as an investor class for private equity.


Private-equity fund performance

Due to limited disclosure, studying the returns to private equity is relatively difficult. Unlike mutual funds, private-equity funds need not disclose performance data. And, as they invest in private companies, it is difficult to examine the underlying investments. It is challenging to compare private-equity performance to public-equity performance, in particular because private-equity fund investments are drawn and returned over time as investments are made and subsequently realized. An oft-cited academic paper (Kaplan and Schoar, 2005) suggests that the net-of-fees returns to PE funds are roughly comparable to the S&P 500 (or even slightly under). This analysis may actually overstate the returns because it relies on voluntarily reported data and hence suffers from
survivorship bias Survivorship bias or survival bias is the logical error of concentrating on entities that passed a selection process while overlooking those that did not. This can lead to incorrect conclusions because of incomplete data. Survivorship bias is ...
(i.e. funds that fail won't report data). One should also note that these returns are not risk-adjusted. A 2012 paper by Harris, Jenkinson and Kaplan, 2012 found that average buyout fund returns in the U.S. have actually exceeded that of public markets. These findings were supported by earlier work, using a data set from Robinson and Sensoy in 2011. Commentators have argued that a standard methodology is needed to present an accurate picture of performance, to make individual private-equity funds comparable and so the asset class as a whole can be matched against public markets and other types of investment. It is also claimed that PE fund managers manipulate data to present themselves as strong performers, which makes it even more essential to standardize the industry. Two other findings in Kaplan and Schoar in 2005: First, there is considerable variation in performance across PE funds. Second, unlike the mutual fund industry, there appears to be performance persistence in PE funds. That is, PE funds that perform well over one period, tend to also perform well the next period. Persistence is stronger for VC firms than for LBO firms. The application of the Freedom of Information Act (FOIA) in certain states in the United States has made certain performance data more readily available. Specifically, FOIA has required certain public agencies to disclose private-equity performance data directly on their websites. In the United Kingdom, the second largest market for private equity, more data has become available since the 2007 publication of the David Walker Guidelines for Disclosure and Transparency in Private Equity.


Taxes

Income to private equity firms is primarily in the form of "
carried interest Carried interest, or carry, in finance, is a share of the profits of an investment paid to the investment manager specifically in alternative investments (private equity and hedge funds). It is a performance fee, rewarding the manager for enhanci ...
," typically 20% of the profits generated by investments made by the firm, and a " management fee," often 2% of the principal invested in the firm by the outside investors whose money the firm holds. As a result of a tax loophole enshrined in the U.S. tax code, carried interest that accrues to private equity firms is treated as capital gains, which is taxed at a lower rate than is
ordinary income Under the United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, sta ...
. Currently, the long term capital gains tax rate is 20% compared with the 37% top ordinary income tax rate for individuals. This loophole has been estimated to cost the government $130 billion over the next decade in unrealized revenue. Armies of corporate lobbyists and huge private equity industry donations to political campaigns in the United States have ensured that this powerful industry receives this favorable tax treatment by the government. Private equity firms retain close to 200 lobbyists and over the last decade have made almost $600 million in political campaign contributions. In addition, through an accounting maneuver called "fee waiver," private equity firms often also treat management fee income as capital gains. The U.S.
Internal Revenue Service The Internal Revenue Service (IRS) is the revenue service for the Federal government of the United States, United States federal government, which is responsible for collecting Taxation in the United States, U.S. federal taxes and administerin ...
(IRS) lacks the manpower and the expertise that would be necessary to track compliance with even these already quite favorable legal requirements. In fact, the IRS conducts nearly no income tax audits of the industry. As a result of the complexity of the accounting that arises from the fact that most private equity firms are organized as large partnerships, such that the firm's profits are apportioned to each of the many partners, a number of private equity firms fail to comply with tax laws, according to industry
whistleblower A whistleblower (also written as whistle-blower or whistle blower) is a person, often an employee, who reveals information about activity within a private or public organization that is deemed illegal, immoral, illicit, unsafe or fraudulent. Whi ...
s.


Debate


Recording private equity

There is a debate around the distinction between private equity and
foreign direct investment A foreign direct investment (FDI) is an investment in the form of a Controlling interest, controlling ownership in a business in one country by an entity based in another country. It is thus distinguished from a foreign portfolio investment by ...
(FDI), and whether to treat them separately. The difference is blurred on account of private equity not entering the country through the stock market. Private equity generally flows to unlisted firms and to firms where the percentage of shares is smaller than the promoter- or investor-held shares (also known as free-floating shares). The main point of contention is that FDI is used solely for production, whereas in the case of private equity the investor can reclaim their money after a revaluation period and make investments in other financial assets. At present, most countries report private equity as a part of FDI.


Healthcare investments

Private-equity investments in health care and related services, such as nursing homes and hospitals, are alleged to have decreased the quality of care while driving up costs. Researchers at the Becker Friedman Institute of the
University of Chicago The University of Chicago (UChicago, Chicago, U of C, or UChi) is a private university, private research university in Chicago, Illinois. Its main campus is located in Chicago's Hyde Park, Chicago, Hyde Park neighborhood. The University of Chic ...
found that private-equity ownership of nursing homes increased the short-term mortality of Medicare patients by 10%. Treatment by private-equity owned health care providers tends to be associated with a higher rate of "surprise bills". Private equity ownership of dermatology practices has led to pressure to increase profitability, concerns about up-charging and patient safety.


Wealth capture

According to conservative Oren Cass, private equity captures wealth rather than creating wealth, and this capture can be "zero-sum, or even value-destroying, in aggregate." He describes "assets get shuffled and reshuffled, profits get made, but relatively little flows toward actual productive uses."


Influence on inequality

''Bloomberg Businessweek'' states that:
PE may contribute to inequality in several ways. First, it offers investors higher returns than those available in public stocks and bonds markets. Yet, to enjoy those returns, it helps to already be rich. Private equity funds are open solely to “qualified” (read: high-net-worth) individual investors and to institutions such as endowments. Only some workers get indirect exposure via pension funds. Second, PE puts pressure on the lower end of the wealth divide. Companies can be broken up, merged, or generally restructured to increase efficiency and productivity, which inevitably means job cuts."


See also

* Common ordinary equity * History of private equity and venture capital * Private investment in public equity * Publicly traded private equity * Specialized investment fund * Search fund


Organizations

* Institutional Limited Partners Association – advocacy organization for investors in private equity * American Investment Council – advocacy and research organization for the industry


Notes


Further reading

* * * * * * * * * * * * * * *
Private Inequity
by James Surowiecki, The Financial Page, ''
The New Yorker ''The New Yorker'' is an American weekly magazine featuring journalism, commentary, criticism, essays, fiction, satire, cartoons, and poetry. Founded as a weekly in 1925, the magazine is published 47 times annually, with five of these issues ...
'', 30 January 2012. * * *


External links


Archive of articles on private equity controversies in the 21-st century
'' Naked Capitalism'' {{DEFAULTSORT:Private Equity Investment Equity securities Corporate finance Financial markets