So what exactly is private equity? Essentially, it’s an investment in companies that are underperforming or badly run. Private equity funds can buy up a company for any reason, and many of them are organized as limited partnerships. However, there are many other reasons why private equity is popular with businesses. Read on to learn more (https://www.sidley.com/en/us/services/private-equity/). The most common one is to create jobs. Here’s how private equity makes money.
Investments in underperforming companies
In the past few years, the phenomenon of private equity has gained considerable popularity. The firms that invest in such companies are known to make huge profits from their investments. Some of their methods of investing include aggressive use of debt, a focus on margins and cash flow, and freedom from public company oversight. But this new approach may not be right for every company. Listed companies may not be the best choice for private equity.
One of the biggest benefits of private equity investing is the promise of higher returns than those in the stock market. But this return is only possible if the investment is made by a wealthy individual or institution. For example, a firm like KKR has claimed to generate gross returns of 25.6% since its inception in 1991. That return is higher than the S&P 500 index. The problem with this strategy is that the investment is often illiquid and highly leveraged.
Investments in restructured companies
Restructuring companies are a natural place for private equity. Companies are struggling to meet interest payments or may be on the verge of a cash crunch. Distressed companies have already defaulted on debt, violated covenants, or entered the bankruptcy process. The private equity investor wants to help them achieve the best possible outcome. Sometimes, a restructuring group can advise governments about potential reorganizations.
Governments often encounter currency problems, political upheaval, or other circumstances that force a company into a restructuring. As a result, debtors and creditors may come together in a deal to save the company. The banks, subordinated lenders, and mezzanine lenders, for example, may be involved in the restructuring deal. Generally, banks are trying to obtain the best terms for their creditors, including the highest percentage of repayment. Some of the deals will require a debt-for-equity swap. Often, a struggling company needs to close locations that are not profitable, so restructuring consultants may be necessary to assist in this process.
Investments in companies that aren’t well-run
As the media has become more critical of private equity, the industry has come under fire as well. For example, the downfall of Payless Shoes, Deadspin, Shopko, and RadioShack can all be traced back to the practice. In addition, Taylor Swift blamed the industry for her music battle with Drake, blaming the “unregulated world of private equity.” The same can be said of surprise medical bills and the gripes of Hollywood writers about the industry. Now, politicians are taking note, and the industry is facing even more criticism than before.
Unlike traditional investment firms, PE firms do not usually focus on investing in companies that have performed well. Unlike mutual funds, which invest in companies with a good track record, private equity firms focus on companies facing headwinds. These companies generally lose money to shareholders. Ultimately, PE investors are looking for a better opportunity to turn around companies that aren’t well-run.
Investments in businesses that aren’t well-run
There are some advantages to taking a public company private. While it may improve performance, it often involves large changes and tests the private equity firm’s implementation skills. In the case of Wincor Nixdorf, KKR and GS Capital Partners purchased a unit of Siemens in 1999. They worked with management and followed their plan to turn around the company. Taking Toys “R” Us private meant resigning top executives and establishing a new strategy.
One major downside is that Private Equity investors rarely want to take over a company’s management and typically do not replace the current leadership of the company. They are interested in making changes to the company’s operations but not in running it themselves. That’s why most investors don’t want to take over a business that’s not well-run. This can be problematic for companies that have a difficult time performing well on the stock market.