Private Equity

Can we LBO that?
Background

Investment of equity capital in private companies

Private equity firms usually establish a fund and use it to do in private markets what mutual funds do in public markets, with a key difference. Rather than buying shares of public companies, PE funds often acquire private or public companies in their entirety or take part in a consortium and buy out such companies (a leveraged buyout). This to actively manage them - and increase their worth or extract value before exiting the investment.

The deal structure often consists of more parties, as the PE firm, for example, may be investing $5M themselves, raises another $5M from institutional investors, and receives another $10M in the form of loans from commercial banks.

Then, sold as premium?

The PE firm earns its money by charging a management fee for all the capital it has raised and additional money when the acquiree - often equipped with a new management team and streamlined operations - is sold at a premium compared to the initial investment. In the meantime, the management fees free the PE fund to buy more businesses.

Investment targets for private equity firms are often underperforming businesses that are bought in the belief that their profitability will improve with the help of the firm's management expertise.