The huge sums that private equity firms make on their investments evoke admiration and envy. Typically, these returns are attributed to the firms’ aggressive use of debt, concentration on cash flow and margins, freedom from public company regulations, and hefty incentives for operating managers. But the fundamental reason for private equity’s success is the strategy of buying to sell—one rarely employed by public companies, which, in pursuit of synergies, usually buy to keep.
The chief advantage of buying to sell is simple but often overlooked, explain Barber and Goold, directors of the Ashridge Strategic Management Centre. Private equity’s sweet spot is acquisitions that have been undermanaged or undervalued, where there’s a onetime opportunity to increase a business’s value. Once that gain has been realized, private equity firms sell for a maximum return. A corporate acquirer, in contrast, will dilute its return by hanging on to the business after the growth in value tapers off.
Public companies that compete in this space can offer investors better returns than private equity firms do. (After all, a public company wouldn’t deduct the 30% that funds take out of gross profits.) Corporations have two options: (1) to copy private equity’s model, as investment companies Wendel and Eurazeo have done with dramatic success, or (2) to take a flexible approach, holding businesses for as long as they can add value as owners. The latter would give companies an advantage over funds, which must liquidate within a preset time—potentially leaving money on the table.
Both options present public companies with challenges, including U.S. capital-gains taxes and a dearth of investment management skills. But the greatest barrier may be public companies’ aversion to exiting a healthy business and their inability to see it the way private equity firms do—as the culmination of a successful transformation, not a strategic error.
FAQs
Finding a job in private equity is hard because PE jobs are very competitive, and there are, comparatively, not that many private equity jobs available.
What is a strategic private equity? ›
Strategic private equity refers to an organization's decision-making process to buy a platform company.
Does private equity beat the S&P 500? ›
As the chart shows, private equity funds have outperformed the S&P 500 over the long-term. In exchange for these compelling returns private equity investors give up the level of liquidity and transparency inherent to public markets.
How hard is it to break into private equity? ›
Landing a career in private equity is very difficult because there are few jobs on the market in this profession and so it can be very competitive. Coming into private equity with no experience is impossible, so finding an internship or having previous experience in a related field is highly recommended.
Is private equity a lot of math? ›
Private equity firms usually seek someone with a strong sense of numbers. As such, the majors they generally look for include Finance, Accounting, Statistics, Mathematics, or Economics. GPA will, of course, be a factor here.
What is the biggest challenge in private equity? ›
Slow economic growth, labor issues, high interest rates, inflation, geopolitical tensions, potential recessionary pressures, and instability could all dampen fundraising and exit opportunities. Despite the slowdown in 2023, private equity firms remain optimistic.
What is the average life of a private equity fund? ›
The life cycle of a typical private equity fund is usually ten years, but that ten years generally doesn't start until the team raises substantial capital and it doesn't end until all assets are sold. So, the life cycle of a private equity fund may stretch to as long as 15 years.
What is the minimum investment for private equity? ›
What is the minimum investment required for private equity? For PE funds, minimums generally range from $25,000 to several million alongside the requirements associated with being an accredited investor or qualified purchaser. Crowdfunding platforms tend to have lower minimums.
Can private equity make you rich? ›
Private equity investments tend to have a higher return than the S&P 500, according to a report published by Michael Cembalest, chair of market and investment strategy for J.P. Morgan Asset & Wealth Management. Some people say that these opportunities for wealth generation should be available to more Americans.
What is the 10 year return for private equity? ›
15.2% – The private equity median annualized return over a 10-year period, higher than all other asset classes including public equity, real estate, and fixed income.
Private equity produced average annual returns of 10.48% over the 20-year period ending on June 30, 2020. From 2000 to 2020, private equity outperformed the Russell 2000, the S&P 500, and venture capital.
What is the 80/20 rule in private equity? ›
The typical split in profits between LPs and GP is 80 / 20. That means, the LP gets distributed 80% of the profits on an exit (after returning their initial capital) and the GP keeps 20% of the profits.
What is the dark side of private equity? ›
Private equity firms could inadvertently impose an externality on the economy by reducing citizen-investors' exposure to corporate profits and thus undermining popular support for business-friendly policies. This can lead to long-term reductions in aggregate investment, productivity, and employment.
What is the rule of 20 in private equity? ›
This is also known as the “2 and 20” fee structure and it's a common fee arrangement in private equity funds. It means that the GP's management fee is 2% of the investment and the incentive fee is 20% of the profits. Both components of the GPs fees are clearly detailed in the partnership's investment agreement.
Why is private equity stressful? ›
High Financial Stakes and Performance Pressure
The inherent risk of a substantial financial loss if investments do not perform as expected amplifies the stress, making every decision critical.
What is the problem with private equity? ›
Private equity funds are illiquid and are risky because of their high use of debt; furthermore, once investors have turned their money over to the fund, they have no say in how it's managed. In compensation for these terms, investors should expect a high rate of return.
Is private equity a hard job? ›
At the start of your career in private equity, the workload can be intense, especially as an analyst. Analysts are the backbone of the early deal process, responsible for sourcing potential investments, conducting initial research, and preparing the groundwork for more senior team members.
Is private equity harder than banking? ›
Both investment banking and private equity are demanding careers that require long working hours, although private equity firms tend to have a more relaxed work environment and offer a more flexible schedule.
