The changing face of private equity

Cheat sheet: A quick guide to the inner workings of private equity and how it has changed over the years.

by Paul Simpson
Last Updated: 22 Mar 2022

The very first private equity companies raised finance from institutions and wealthy individuals to invest by buying and selling (equity in) businesses.

They set out to raise a set amount of money to invest over a specific time frame (no more than 10 years, often less). When the deadline arrived, the fund was liquidated and all the businesses sold (unless everyone involved agreed to extend the deadline, possibly because of market uncertainty). If the fund made a large profit, the firm could easily raise money for future funds.

These arrangements often imposed some constraints on what a company could do with the money but investors had virtually no control over private equity managers while the fund was operating. 

With a representative on the board of the companies they invested in, private equity firms typically encouraged senior managers to put their money into the business in expectation of large rewards when it was sold.

In this traditional model, private equity companies offered advice to businesses but did not directly intervene in day-to-day operations.

If the funds were dealing with large businesses, private equity firms would typically charge investors a fee of 1.5-2% of assets under management and, providing they achieved an agreed minimum rate of return for investors, take 20% of all profits when the fund was liquidated.

Investments in individual businesses tended to generate better returns if they were largely financed by debt so private equity firms were most attracted to businesses with stable cash flow, which only needed modest capital investment, that enjoyed reasonable prospects for growth where performance – and therefore value – could be significantly improved in the short to medium term. Because this model relied on debt, it was risky, especially if markets turned volatile. The largest ever buyout – of Texan energy firm TXU in 2007 – turned sour when economic recession restricted demand for electricity.

Over the past decade, private equity strategies have become more varied. The buy-to-sell model is still popular but a giant such as KKR, which has become as large and diverse as the corporate conglomerates it eclipsed in the 1980s, now behaves more like an asset management company.

Some private equity firms get directly involved in their businesses, often as efficiency consultants, sometimes calling on skills and knowledge within their network, using their corporate clout to get better deals from suppliers and – usually as a last resort – firing and hiring the company’s leaders.

Whether you like the private equity model or not, it is here to stay. The California Public Employee Retirement System, the largest US public pension, is looking to raise its investment in private equity by around $25bn. There are now more than 7,000 private equity firms in the US and they control, some estimates suggest, 10-15% of the economy.

Even in the UK, where private equity is less well established, these firms control such familiar names as the AA, Addison Lee, Asda, Aston Villa FC, G4S, John Laing, McCarthy & Stone, Morrisons, PG Tips, Prezzo, the RAC and TalkTalk. Private equity investors also have significant stakes in the owners of Liverpool FC and the Six Nations international rugby tournament, and are frontrunners to acquire the Northcliffe regional newspaper empire from the Daily Mail.


Go figure

40%

Decline in the number of companies listed on the UK stock market since its peak in 2007.

1,000,000

British workers employed by companies with private equity shareholders.

$22bn

The sum investors, backed by KKR, paid to acquire Boots in 2007. Boots was the first FTSE 100 company to go private and the £11bn deal still stands as the largest private equity buyout in the UK.

$44bn

The amount that investors, led by KKR, TPG Capital and Goldman Sachs, paid to acquire US energy group TXU in 2007. It remains the most expensive private equity buyout ever.

$34bn

The amount a private equity investment consortium, led by Blackstone, Carlyle and Hellman & Friedman, paid for a majority stake in US medical supply firm Medline last June, the largest private equity deal of 2021 and the biggest since the 2007 financial crisis.

6,298

Private equity deals completed worldwide in the first six months of 2021, the highest tally since records began more than 40 years ago.

£385bn

The combined value of those deals in the first half of 2021, also a record for the private equity sector.

£34bn

The combined value of private equity deals in the UK in the first half of 2021, more than double the previous record for any similar period.

40%

The average premium private equity firms offered on market prices to acquire British companies in the first half of 2021.

£534bn

The amount of finance private equity firms have raised this year which, analysts expect, will be invested throughout 2022.


Image credit: Aping Vision/STS via Getty Images

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