Private equity
Private equity refers to investments made in privately owned companies with the aim of acquiring partial or full ownership. Unlike public company investments, which involve stocks traded on stock exchanges, private equity specifically focuses on unlisted businesses. Investors typically engage with private equity firms, which pool substantial capital and target established private companies, often aiming for profitable returns through strategic buying and management. Investments can involve significant sums, with firms sometimes requiring minimum contributions ranging from $250,000 to millions.
While private equity investing has the potential for high returns, it carries unique risks, such as lower liquidity and a lack of public financial disclosures from private companies. Nevertheless, it offers benefits such as greater long-term focus on business growth and quicker profit distribution compared to public companies. Private equity gained momentum in the U.S. during the late 1970s, leading to the establishment of numerous influential firms. Despite mixed perceptions regarding its impact on corporate culture, private equity has been a driving force in the growth of many private enterprises.
Private equity
In business and finance, private equity is an investment made in a privately owned company to acquire partial or full financial ownership of that company. Equity is a figure that represents a business's financial value. The defining characteristic of private equity is that it only involves investments in private companies. It is not concerned with investments made in public companies whose stock is traded among shareholders on stock exchanges.
How Private Equity Works
Private equity refers specifically to investments of large sums of money made in privately owned companies to see a profitable return. This general explanation of the term appears to place private equity in the same league as other types of high-finance investments such as venture capital and stock market investing, but the three are distinct from one another.
Venture capital is money invested in new businesses to help them acquire long-term financial stability and ultimately make profits for their investors. Meanwhile, stock market investments involve buying shares of public companies. These businesses allow ordinary people to purchase stock and acquire returns on their investments if the stock performs well.
Like venture capital and stock market trading, private equity's primary purpose is to make profits for investors. But private equity applies only to those funds invested in established, private companies that are not listed on stock exchanges. Individuals seeking to invest private equity in such companies generally begin by soliciting the services of private equity firms. These firms accept their clients' money and invest it in companies that they suspect will yield profits. Some equity firms mandate minimum investments of $250,000 or up to several million dollars. Once the firms have accumulated enough funds from their investors, they begin buying shares of various private companies around the world.
Owning shares means that the private equity firms control certain percentages of these companies based on the amount of money they have invested. Sometimes the firms use their investments to purchase entire companies in practices known as leveraged buyouts. In either case, the firms hold onto their company shares for a standard period of between four and ten years.
Eventually, the equity firms hope to sell their company holdings for more than what they paid for them and return most of the profits to their original investors. For managing the investments at every step of the process, the firms charge their clients an annual fee of about 1 to 2 percent of the client's total invested funds and ultimately claim 20 percent of the profits for themselves.
Risk in Private Equity Investing
Prudently investing private equity in successful companies can make investors, and the firms they hire, extraordinarily wealthy. However, private equity investment comes with a unique set of financial risks that are not present in public company investments on the stock market.
One disadvantage of investing in the private market is that private assets, or financial resources, do not always hold the necessary liquidity to make profits from selling them. Liquidity is the extent to which a resource can be quickly bought and sold while retaining its monetary value. The assets of public companies on the stock market have high liquidity because they can change hands fast, but private assets can often take years to increase in value as buyers and sellers bargain over prices.
Another risk of investing private equity is that, unlike public companies, private companies are not legally obligated to disclose their financial standings to the public. This means that potential private company investors may not know the investment history or even the trustworthiness of the businesses in which they choose to invest. But even if a private corporation is financially reliable, private equity investments can involve hundreds of millions or even billions of dollars, all of which can be lost if the assets lose their liquidity and the investments fail.
Benefits of Private Equity Investing
Despite these inherent risks, investing private equity in privately owned businesses has some advantages over public company investing. For example, some public companies, to satisfy the short-term financial predictions of Wall Street analysts, devote too much attention to meeting quarterly financial plateaus while disregarding long-term planning. Conversely, private companies may take longer to return profits to their investors, but they also dedicate more time and effort to building better products for the future.
Another benefit of choosing private equity over the stock market is that private profits are distributed to business owners and investors quickly and directly. Public companies usually reinvest their earnings immediately unless investors choose to be paid their dividends, or profitable returns. Research performed on both public and private companies has also indicated that private businesses are better organized and productive, which leads to expansion and the creation of more jobs. This kind of growth can result in larger profits for owners and investors.
Notable Private Equity Investors
Investing private equity in large corporations became a booming industry in the United States in the late 1970s. At that time, the federal government reduced the capital gains tax rate, the tax on corporate investments, from 49 percent to 28 percent, making large-scale investing more attractive to businesspeople. As a result, throughout the 1980s, the United States saw the rise of many successful private equity firms that began investing in private corporations.
Some of these included KKR & Co. Inc. (founded 1976), Bain Capital (1984), Blackstone Group (1985), Carlyle (1987), and ABRY Partners (1989). These firms executed leveraged buyouts of numerous companies. One of the most famous of these was KKR's $31.1 billion buyout of the RJR Nabisco company in 1988, which was the largest corporate takeover in history at the time. During this era, many Americans came to feel that such practices represented the pure greed and hostile capitalism of corporate American culture. In the cases of these firms and others, however, the investing of private equity proved enormously successful. That success continued into the twenty-first century, and though negative sentiments continued to exist regarding private equity firms, some analysts credit such firms with saving smaller, failing banks after the 2008 financial crisis.
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