What Private Equity Firms Are and How They Operate
Chris Morran  and  Daniel Petty (ProPublica) 04 August 2022
This story was originally published by ProPublica.
Private equity firms have grown substantially since the 1980s and now manage more than $6 trillion in assets in the United States. Their presence has affected industries from hospitals to fisheries.
Private equity is seemingly inescapable. From housing to hospitals and fisheries to fast food, equity investors have acquired a host of businesses in recent decades. Private equity firms control more than $6 trillion in assets in the U.S. But what makes them different from any other type of investor putting their money into a business?
Private equity investors — typified by firms like Bain Capital, Apollo Global Management, TPG, KKR and Blackstone — are different from venture capitalists, who provide a cash infusion to small startups and hope they blossom into the next Facebook. Nor are they stock traders making split-second decisions to buy or sell shares in public companies. Rather, private equity funds aim to take control of a business for a relatively short time, restructure it and resell the company at a profit.
But as ProPublica and many others have shown, the ways in which private equity goes about this restructuring can raise a number of concerns, over such things as layoffs and furloughs for employees and degraded services for customers. Critics also worry that private equity firms weigh down acquired companies with substantial debt from the money borrowed to finance the purchase.
What Is Private Equity?
Private equity funds are pooled investments that are generally not open to small investors. Private equity firms invest the money they collect on behalf of the fund’s investors, usually by taking controlling stakes in companies. The private equity firm then works with company executives to make the businesses — called portfolio companies — more valuable so they can sell them later at a profit.
This is different from, say, an individual investor buying a share of Amazon stock for $135. Purchasing that share gives you an infinitesimal stake in the company and entitles you to any dividend the company may pay out, but your ownership stake isn’t large enough to affect the company’s decision-making and operations. Private equity funds, by contrast, are not publicly traded securities, and the amount they invest usually involves trying to take a controlling stake in companies.
Private equity funds are generally backed by investments from large institutional investors: pension funds, sovereign wealth funds, endowments and very wealthy individuals. Private equity firms manage these funds, using both investors’ contributions and borrowed money.
Like any business, private equity firms want to make money, generating returns for their investors. Fund managers typically spend time conducting extensive research on both companies and industries — called due diligence — before making an investment. They consider multiple factors when deciding to invest. Among them are whether a company operates in an industry that’s difficult for other competitors to enter, generates consistent profits (or can become profitable), provides a reliable cash flow so it can pay off debt, has a strong position or brand within its market, has an effective management team, isn’t likely to face disruptive change through technologies or regulation and may be underperforming relative to other companies in its industry.
As of September 2020, about one-third of North American private equity firms’ $6.5 trillion in assets were so-called “dry powder”: cash or highly liquid securities that could be quickly invested at the right opportunity. The growth of private equity and other forms of private investment has, experts say, resulted in fewer companies going public and many more staying private for longer.
What Do Private Equity Firms Do?
Once private equity firms acquire a company, they encourage executives to make the company operate more efficiently before selling — or “exiting” — several years later, either through a sale to another investor or through an initial public offering.
“The number one factor private equity firms focus on now is the ability to grow the revenue of the company,” Steven Kaplan, a professor of entrepreneurship and finance at the University of Chicago Booth School of Business, said in an email. Other considerations, Kaplan said, include reducing costs, refinancing existing debt and multiple arbitrage — the latter a term describing how private equity funds try to acquire firms trading below their intrinsic value…
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