Private Equity: Firms, Funds, Trends

Here Are the Multi-billion Dollar Deals that You Can't Even Invest In

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Private equity deals don't involve selling stock on the market. Photo: John Slater/Getty Images

Definition: Private equity is private ownership, as opposed to stock ownership, of a company. The private equity investors can buy all or part of a private or public company. Private equity investors usually have a five to ten year time horizon. However, they typically look for a $2.50 return for every dollar invested. (Source: Simon Clark, "Blackstone Wants More Range to Buy," Wall Street Journal, February 26, 2015)

If all of a public company is bought, it results in a delisting of that company on the stock exchange. This is called "taking a company private." It's usually done to rescue a company whose stock prices are falling, giving it time to try growth strategies that the stock market may not like. That's because private equity investors are willing to wait longer to obtain a higher return, while stock market investors generally want a return that quarter if not sooner.

Since it has a longer time horizon than typical stock investors, private equity can be used to fund new technologies, make acquisitions, or strengthen a balance sheet and provide more working capital. Private equity investors hope to beat the market in the long run by selling their ownership at a great profit either through an IPO (Initial Public Offering) or to a large public company.

Private Equity Firms

These private stakes in a company are usually bought by private equity firms.

Firms can keep the holdings, or sell these stakes to private investors, institutional investors (government and pension funds), and hedge funds. Private equity firms can either be privately held, or a public company listed on a stock exchange.

The private equity business is dominated by big investors who are looking for big deals.

In fact, the top ten firms own half of the worldwide private equity assets ($959 billion excluding venture capital). Here's a list of these firms and their assets:

  1. Oaktree Capital Management - $77.1 billion
  2. Kohlberg Kravis Roberts - $71.5 billion
  3. Bain Capital - $66.5 billion (12% increase)
  4. TPG Capital - $54.5 billion (10% increase)
  5. Carlyle Group - $53.3 billion
  6. Blackstone Group - $51 billion (11% increase)
  7. Apollo Global Management - $37.8 billion
  8. Ares Management - $34 billion
  9. Advent International - $32.7 billion (67% increase)
  10. Warburg Pincus - $30 billion. (Source: Pensions & Investments, Largest Private Equity Firms Rule the Roost, April 1, 2013. Largest Private Equity Managers, December 31, 2012)

Private Equity Funds

The money raised by these firms are called private equity funds. It usually comes from institutional investors, like pension funds, sovereign wealth funds, and corporate cash managers, as well as family trust funds and even wealthy individuals. It can include cash and loans, but not stocks or bonds.

Prequin, a private equity analyst, divides private equity funds into five major types.

  1. Distressed - Investors focus on turnarounds of companies in trouble. Not surprisingly, this category has done the best since the 2008 financial crisis.
  1. Buyout - Investors focus on buying out a company completely. This is the second best performer.
  2. Real Estate - Focuses on commercial real estate, such as apartment companies and REITs. This was the third best performer.
  3. Fund of Funds - Invests in other private equity funds.
  4. Venture Capital - Investors, often called "angels", take part ownership of a start-up in return for seed money. These investors hope to sell the company once it becomes profitable. They often provide expertise, direction and contacts to get the company off the ground. They often fund many companies, knowing that only one will really become successful. However, this one success could more than outweigh all the losses.

All categories except for venture capital have outperformed the S&P 500. (Source: Prequin, Private Equity Quarterly, March 2013)

Current Trends

Blackstone Group is talking to its large investors about creating a fund that has an even longer term, say 15 years,and a lower return of "only" 14%.  That would make it similar to Warren Buffett's Berkshire Hathaway.  The push for this trend is institutional investors who are looking for steady returns for the long-term. (Source: Clark, WSJ)

Blackstone, KKR, and Carlyle Group are courting private investors since they don't have enough institutional investors to provide all the funds they need. Investors with $5 million or more usually only have 2%-3% in alternative investments, lower than the 19% recommended by wealth managers. Private equity funds can meet this need. However, management fees run 1.5%-2%, with banks and fund managers adding 0.25% - 0.5%. (Source: Robert Milburn, "Private Equity Courts the Well-to-Do, Barron's April 27, 2015.)

Did Private Equity Help Cause the Financial Crisis?

According to Prequin.com, $486 billion of private equity funding was raised in 2006. This additional capital took many public corporations off the stock market, thus driving up the share prices of those that were left. In addition, private equity financing allowed corporations to buy back their own shares, also driving remaining share prices up. (Source: Prequin, Private Equity Spotlight October 2007)

Many of the loans that banks make to the private equity funds were then sold as CDOs (collateralized debt obligations). The result was that the banks didn't care if the loans were good or not, because someone else was stuck with the bad loan. In addition, the impact of these loans going sour were felt in all financial sectors, not just banks. The excess liquidity created by private equity was one of the causes of the 2007 Banking Liquidity Crisis and subsequent recession.