What is Private Equity? | Wall Street Simplified

hey what's up everyone unless you've been living under a rock you probably heard the term private Equity or PE whenever careers in finance are discussed private Equity is inevitably spoken about as if it is a glorious Promised Land of vast riches and wealth and the argument could be made that that is relatively accurate PE firms have been known to rate in millions of dollars not just for their investors but also for themselves after all Steven Schwarz spent the CE of Blackstone was the highest paid executive in the world last year he brought in total annual compensation of more than $ 1.25 billion that's 10 figures and that's probably why everyone is trying to get into the industry whether it's burnt out Investment Banking analysts or social media influencers but even Amit the allore I have recently noticed in the news and media that private Equity is generally misunderstood the industry is often pay tainted as an evil villain wreaking havoc on Middle America which is an argument that may have some Merit although I do happen to think that PE still does more good than bad but that's beyond the scope of this video instead today I plan to discuss the foundations of private equity and what you need to know about the industry this is by no means a comprehensive breakdown I'm going to leave that to the pros but I do think that you will leave this video a much more informed student professional or Grandma hi Nana if this is your first time watching one of my videos then hey my name is Cameron galri and I am a finance professional here in New York City this video is part of my new series Wall Street simplified where I break down opaque Finance topics into easy to understand videos if you're not already make sure to subscribe to my channel so you don't miss an upload today's video will be broken up into four topics first what is private Equity then how the private Equity firms create value followed by the different private Equity investment strategies and finally how private Equity firms exit a deal so with that said let's get into it so as the name suggests private Equity is the ownership or interest in an entity that is not publicly listed or traded so unlike Apple which is listed on the NASDAQ and anyone can buy a share of private Equity deals strictly with companies that are privately owned and typically not available to the average person private Equity is actually the term for the source of investment Capital private Equity Investments come from firms that purchase stakes in private companies or alternatively acquire control of public companies with the intention of taking them private and ultimately delisting them from stock exchanges AKA a go private like any investment private Equity is used to buy companies with the hope that the company's value will increase over time but unlike a hedge fund or an asset management fund private agre firms often play a much more active role in increasing their portfolio company value similar to hedge funds a private Equity firm's Partners raise funds from investors like wealthy individuals and institutional investors with the goal of generating a positive return not available elsewhere the time Horizon of these funds and Investments is typically between four to seven years that is the standard time the private Equity firms feel they need in order to find and turn a business around which leads us into how the private Equity firms create this value so private Equity firms perform two critical functions which work in phases this includes deal origination and transaction execution which leads into portfolio oversight and management according to Investopedia deal origination and execution involves creating maintaining and developing relationships with m&a intermediaries investment Banks and similar transaction professionals these relationships secure both high quality and high quantity deal flow and often is how firms or refer to prospective acquisition candidates because the nature of PE is Finding Diamonds in the Rough and boosting their value firms spend a lot of time searching for acquisition targets but unlike the public markets once a Target is identified the firm still have actually convince the current owners to sell which is often easier said than done during the search process firms leverage a lot of metrics and tools like the current executive team the industry Revenue forecasts and of course plenty of valuation models but once the due diligence is complete and ay is acquired by AP firm the second function can begin portfolio oversight management is the process of strengthening the business this is done in numerous ways but can most succinctly be phrased as increasing operational efficiencies it's this aspect of private Equity that sometimes gives it an ominous reputation firms aren't known to slash costs and cut any fat that they can find this typically means reducing overhead by laying off employees that aren't providing sufficient value to the company alternatively firms occasionally raise prices to boost revenue and partake in other Revenue generating activities that maybe the old company didn't do a good example of this is jaab Holdings which is a European investment firm they famously created successful subscriptions for two of their portfolio companies prange and Panera this is boosted profits for both firms and is something I discuss at length in another video on my channel but sometimes a company doesn't need an entire overhaul often times a change in it accounting or even just branding can boost the value of a company what is important to know is that private Equity investors aim to find ways for the businesses to improve iida or earnings before interest tax depreciation and amortization this above anything else is the golden metric now that we know the goals of private Equity let's discuss how they're able to execute it financially the most common way that private Equity firms are able to purchase a a business is through a leveraged buyout or lbo if you're currently recruiting for investment banking or private Equity you better know what this is but if not lbos are exactly what they sound like the purchase of a company is financed through debt which is collateralized by the company's operations and assets as the leveraged in lbo suggests private Equity firms are able to assume control of a company while only putting up a fraction of the purchase price in cash UPF front then the debt is pait off by the cash close up the business which if a private Equity Firm does what it's supposed to do should more than cover this expense now this should allow you to see how private Equity can become very profitable when done correctly especially in a time of low interest rates because a private Equity Firm is able to use leverage to buy a company they're only spending a fraction of the purchase price for a business then if a firm can successfully optimize efficiencies and increased profit margins they can Rak in millions of the differential between the interest costs and the cash flow of the improved business this together is then what makes a private Equity portfolio company right for an exit another investment strategy that technically falls under the bucket of private Equity is Venture Capital BC is used to take an equity investment in a young company these companies are often in a less mature industry think internet companies in the early to mid 90s were AI right now I'll be making a separate intro video about venture capital in the coming weeks so again make sure to subscribe so you don't miss that okay so now that a private Equity Firm has bought a company and works to make it more successful it's time to talk about how it exits the investment a typical exit for a middle Market company is to be sold to a large corporation in their vertical or often times and adjacent industry this purchase price paid by the large company should have a substantially higher valuation than what the private reir bought the company at allowing them to sell all their equity in the business and cash out alternatively though some investors might ride their portfolio companies all the way to an IPO allowing investors to ultimately sell their shares in the public market so to wrap this all up private Equity firms invest in private companies that have potential for growth or opportunities to boost earnings the investors then strategically look for ways to increase the value of the company and once this is done the private Equity Firm sells the company for a profit and will use the capital to do it all over again Dan Tumi from the morning breu put it quite simply when he compared private firms to house flippers but instead of houses it's companies and with that said I hope you guys enjoyed this video and if you want to see more content just like this make sure to like And subscribe I plan on doing many more deep dives into different areas of Finance in the future so if you have any topics you want to see make sure to comment them down below and as always if you have any questions at all Reach Out me on Instagram at galberth or connect with me on LinkedIn I hope you enjoyed this video and I'll see you in the next One [Music] Peace