What is a Private Equity Firm?
According to Investopedia, private equity are shares of ownership or interest in an enterprise that is not publicly traded. The goal of private equity firms are to buy businesses and sell them in a few years’ time at a profit. A private equity firm will seek to take control of the ownership of an enterprise that is under-performing and charge the firm for their management expertise as they raise the enterprise’s level of profitability.
We spoke with Rex Burgdorfer advisor on private equity. Burgdorfer is the Vice President of Juniper Advisory. Juniper Advisory is an investment banking firm based in Chicago that specializes in private equity and healthcare finance.
How Do Private Equity Firms Finance and Profit From Acquisitions?
The typical management fee charged by a private equity firm is around 2 percent of the total capital it has raised. The private equity firm also takes a percentage of the capital gain generated when the enterprise has been rehabilitated and is sold.
Often, additional funds that help private equity firms take control of under-performing companies come from pension funds and insurance companies because the goal of private equity firms is a high return on investment, sometimes in the 20 to 30 percent range.
At times, leveraged buyouts will utilize collateral from the enterprise being purchased so that the private equity firm has purchased the business, while only using a small percentage of its own assets in doing so.
The Types of Companies Acquired
According to Entrepreneur Magazine, private equity firms tend to search for established companies that are struggling. New, unproven startups with potential tend to be the realm of the venture capitalists. Private equity firms are looking for established, but struggling businesses that are often in the manufacturing or service sector. They also tend to be interested in acquiring franchises.
What Happens After Acquisition
The private equity firm will have a contract with covenants that it will enforce in order to improve the struggling company’s profitability. This may be accomplished through buying out the founder, changing the management of the company or buying out more investors to have more of a say in the management of the firm.
Some Typical Management Improvements
In their quest to make the struggling firms they acquire more profitable, the private equity firm may institute technological improvements, improve supply-chain management, utilize better data governance and glean more marketing information from data or institute other improvements that make the enterprise more efficient.
Variation: Search Fund
A recent variation on the private equity mechanism is called a search fund. Rather than acquire interest in a business, the equity group will provide funds to an entrepreneur and have the latter search for a suitable business to acquire and manage. Once the entrepreneur has found a suitable enterprise for acquisition, the private equity fund will acquire the struggling business and install their CEO that they have backed financially.
Rex Burgdorfer advisor suggests that a good private equity firm can produce a team that will turn around struggling companies in a few years’ time. Then, the company is often ready for acquisition by a larger player or an IPO.
