Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market. Categories of private equity investment include leveraged buyouts, venture capital, growth capital , angel investing, mezzanine capital and others.
Private equity firms
Private equity firms are managed by individuals known as general partners who will make direct investments on behalf of the limited partners , or those who contribute capital to the fund. General partners are generally compensated with a management fee, defined as a percentage of the fund's total equity capital, as well as carried interest, defined as a percentage of profits generated. Typically, general partners of funds will receive a management fee of 2% and carried interest of 20%. The example below shows how lucrative private equity management can be.
Assuming that the general partners achieve a 10% return (similar to the return of the S&P 500) on a fund of $1 billion, the general partners would receive $20 million in management fees and $20 million in carried interest (20% of the $100 million in profit). However, gross private equity returns may be in excess of 20% per year, which in the case of leveraged buyout firms is primarily due to leverage, and in the case of venture capital firms, due to the high level of risk associated with early stage investments.
Private equity firms include
History
Keynote Speech Delivered by Henry R. Kravis at the Dow Jones Private Equity Analyst Conference in New York City on September 22, 2004 ([12])
When George and I first started doing deals at Bear Stearns in the late 60s, “bootstrap” transactions, were in their infancy. The private equity industry as we know it was not yet born. In the early days, there was very little understanding about what we were proposing among corporations, or among the debt providers we needed to support our buyouts, or among institutional investors. There was limited debt capability and no high yield markets.
The hardest work in the early days was finding capital from investors, financing the transactions, and educating corporations about leveraged buyouts and the meaning of maximizing shareholder value.
This is no longer the case. The businesses we invest in today are better managed companies than those we invested in 10, 20, or 30 years ago. And there is more transparency in business, so it is extremely hard to find a hidden jewel. None of us make money at the time of the acquisition. We only make money because we improve the operations of the newly acquired company, and, subsequently, if capital markets are strong, utilize this capital to our advantage. As a result, we’ve had to get more skilled at building businesses.
So here’s where private equity stands after three decades: First, management ownership has become institutionalized, eliminating for us a relatively simple method of increasing value in our companies. Second, an emphasis on creating shareholder value has become an important driver in powering a dynamic and prosperous U.S. economy, increasing the valuations of our potential investee companies. And finally, as if making money wasn’t hard enough, our success in building businesses by leveraging our flourishing capital markets has led to increased competition from traditional private equity investors as well as from outside the industry. In short, everything we have accomplished in driving corporate excellence makes it harder for us to achieve the returns that our investors expect from us.
Since the days of buying a company on the cheap are pretty much over, and the key driver for success in our business is what you can do with the company after you own it, then intimate knowledge of industries and companies is imperative.
See also
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Industry Organizations & Other Resources
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