Basics and Fundamentals of Private Equity
Investors seek out private equity (PE) to earn returns that are better than what can be achieved in public equity markets. A public equity market is a market in which shares of companies are traded, through familiar exchanges such as the New York Stock Exchange.
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An equity market is a form of equity financing, in which a company gives up a certain percentage of ownership in exchange for capital. This is in contrast to debt financing in which you borrow money from a bank such as a loan.
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A source of investment capital, private equity (PE) comes from high-net-worth individuals (HNWI) and firms that purchase stakes in private companies as owners that will usually be paid in equity positions and preferred interest.
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The structure of the relationship: General Partners (GP)s find and are given the right to manage the private equity asset. GPs are also responsible for attaining capital commitments from investors known as limited partners (LPs). GPs are however liable for the debt service and preferred interest to LPs. LPs do not have liability for the asset and losses are usually limited to the capital committed.
Private Equity
Bank Loan
PLS Equity Partnerships
Target Asset
A leveraged buyout is the acquisition of another company or asset using a significant amount of borrowed money to meet the cost of acquisition. This is usually a mix of debt and equity financing. A loan to purchase an asset ( typically 65-90% of the cost) and investor equity to raise the remaining capital to close. The deal is additionally collateralized by income generated by the asset. This allows private equity to acquire assets with significantly less capital than the closing price of the asset facilitating deal flow and future acquisitions.
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Investors are given a preferred interest with typically higher rates than what banks charge. Typically from 6-12% of the money that is invested. The rate is much higher because PE firms require this money outside of debt service which is much harder to come by.
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After the debt service and preferred interest is paid then LPs and GPs will typically have a profit sharing relationship. The amount that investors get is determined by the LP agreement (LPA) and their ownership percentage of the total equity raised. The percentages can vary widely, typically 40-60%.
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Lastly when the asset is sold, the equity position that the LP has is then paid whatever proceeds are of the sale provided there is a profit as determined by the LPA. Typically split with the GPs and investor ownership percentage of the equity raised.
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