What is private equity?

March 20, 2007 4:15 PM

Please explain private equity firms to me. Assume I'm an economics idiot.

My sister is interviewing with a company which is the target of a private equity takeover. She's concerned about the implications the bid might have for the future of the firm, hence my question. I'm in the UK, if that might make a difference to the terminology used.

posted by punilux to work & money (8 comments total)

Essentially, private equity firms purchase (from management, a family, shareholders, etc) a company or a portion of a company, usually with a small amount of equity (cash) and a large amount of debt (loans, bonds). The private equity firms believe that the firm will generate revenues to provide interest and principal repayment on the debt portion of their investment. The private equity firm may bring in new management or may be satisfied with having a few seats on the board. As for the implications of the newly acquired company, there may be headcuts, cost cuts, future tuck-in acquisitions to the company, or it may be business as usual. See this primer.
posted by Frank Grimes at 4:40 PM on March 20, 2007

Check out the movie Barbarians at the Gate if you want a simple explanation of how private equity firms operate.
posted by any major dude at 4:58 PM on March 20, 2007

Private equity buyers are extremely focussed on cash-flow and have a reputation as cost-cutters. They generally give senior management a chunky stake in the equity of the company and bonuses related to financial performance - which gives them a strong incentive to be cost cutting as well. PE firms have the ability to pay senior management at least the equal of their public company peers so can attract really good managers. They also have cash to invest in opportunities and products as they need a profitable exit in 5 years. My take is that they give established companies a massive kicking - people who are comfortable won't like it, but it opens new opportunities for some. My dad quit a senior management position a few years ago in a company that was taken private by a PE fund - he said it rapidly became too driven by heavily monitored financial targets and cost cutting to be much fun.

This analysis is more focussed towards mid-market deals -- if the job is with (e.g.) Sainsbury's then I don't think PE ownership will make a big difference as they will get their return through clever financing and a sale and leaseback of the property portfolio rather than replacing the management and slashing costs.

The implications for your sister depend on what sort of position she will be applying for. I wouldn't let the potential private equity takeover be the deciding factor, but understand that the culture she sees now could change if it does come off. On the other hand, PE and venture capital firms are always looking for people (especially in finance) with experience of how firms under this sort of ownership operate - having a CV with that sort of experience could be a plus in the future.
posted by patricio at 4:58 PM on March 20, 2007

PE firms are basically bastards. Basically, they try to get a company that they see as "undervalued." They buy the firm, and then basically do financial engineering to improve its value, and hopefully take it public in a few years, at a higher value, giving them lots of profit.

In the process however, they saddle firms with lots of debt and focus on financials. For a tech heavy company, a lot of time this means sacrificing R & D and other fun stuff.

It's not their fault, they just won't know the domain. If the top guys in the company aren't industry guys and are just suits, then it usually means the job sucks.
posted by unexpected at 5:08 PM on March 20, 2007

Companies taken over by private equity investors usually work aggressively to cut costs to service the debt undertaken in the take over.

Mid-level headquarters administrative types are targeted with great zeal: no marketing, legal, planning, or HR job is safe. All staff at underperforming locations are targets, because closing money-losing locations is another key tool in improving cash flow.
posted by MattD at 6:08 PM on March 20, 2007

Besides taking a company public, another popular exit strategy is to sell the company's assets, customers, intellectual property and brand to a competitor or larger player in the given industry. It is possible that employees won't be part of the deal.
posted by M.C. Lo-Carb! at 9:02 PM on March 20, 2007

BBC Radio 4 to the rescue!

A few weeks ago Evan Davis' programme, The Bottom Line, was all about Private Equity. The BBC maintain an archive of all past programs, and you can listen to the 30 minute broadcast here.
posted by humblepigeon at 3:38 AM on March 21, 2007

Thanks everyone, it's much clearer now. Sis is interviewing for an HR position, as it happens. Oops!
posted by punilux at 8:53 AM on March 21, 2007