At a base level, private equity funds raise money for companies in need of a capital infusion. In that respect, they're similar to investment banks. But while investment banks raise money by selling stocks or bonds on the public markets on behalf of client companies, private equity funds do it by raising cash from wealthy individuals and institutions like pension funds. In turn, they use this money to invest in companies.
However, the similarity between PE funds and investment banks ends there. Where investment banks don't take a controlling ownership interest in the companies they take public, PE firms use the capital they raise - along with leverage gained from issuing debt - to assume control of businesses either as co-owners or, often, sole owners.
Like their hedge fund counterparts, private equity funds have seen explosive growth in recent years. According to Fortune magazine, over 1,000 U.S. companies were purchased by private equity funds in 2006 alone. The funds spent, or have committed to spend, in excess of $400 billion for these deals. By any measure, that's a lot of capital.
The managers of private equity funds sometimes pool their resources to buy targeted a company, as happened in several high-profile examples during 2006. In one of the largest such transactions, HCA Inc., the largest for-profit operator of hospitals in the U.S., was purchased by a consortium of four private equity funds for $32 billion.
In some deals, private equity funds use a technique known as a "leveraged buy-out" (LBO) for all or part of the purchase costs. In an LBO, the acquiring group uses loans, bonds or other debt instruments to raise the capital necessary to buy the target. Often, they use the target company's own assets as collateral. Sometimes, the managers of a company work with private equity groups to raise the money necessary to buy the stock of the firm they're running. These deals are known as "management buy outs," or MBOs.
The bottom line is that private equity funds have become a huge force in the global economy, powerful enough to raise concerns over the ability of the largest to pool resources and so drive up deal prices to the point potential industry bidders drop out.
In ideal situations, PE funds invest in underperforming companies, turn them around, and sell their stake at a profit some years later, often in the public markets. Sometimes private equity companies engage in "asset stripping," or breaking up a company and selling its assets separately in order to make their profit.
Venture capital and private equity are often used interchangeably. Strictly speaking, venture capital firms focus on funding promising new businesses, where private equity firms focus on generating value from established businesses through restructurings and better management.
Firms like Texas Pacific Group, Carlyle Group, Bain Capital and Blackstone Group are a few of sector's big players. Firms this big tend to get the most media attention because of the size of the acquisitions they complete. However, many mid-tier firms are also at work, acquiring smaller companies that can benefit from an injection of capital and management talent.
Roles and Career Paths
The private equity industry is booming. One New York recruiter says there is competition for talent at PE firms, which are battling with investment banks and hedge funds for people with the skill sets they need.
At the senior-most levels, PE professionals can make huge sums of money. These are individuals with the experience and contacts to identify, originate and close deals. Below them are the analysts, number-crunchers and lawyers necessary to undertake the due diligence that will make the deals work profitably. According to recruiters, mid-tier firms in particular are seeking to bring more analyst and associate positions in house, rather than rely too much on outside consulting firms to get their work done.
Careers in private equity offer two main entry points. Like their investment bank peers, PE funds prefer people to have a minimum of two to three years of experience at an investment bank, management consulting firm or accounting firm. People emerging from a graduate business school with an MBA program, who have some real-world experience, are also in demand.
Skills and Qualities
- Analytical ability and math aptitude
- Team-working prowess
- Confident and outgoing
- Ability to grow and maintain client relationships