Private equity firms invest private money in businesses they consider attractive. Private equity firms are usually structured as partnerships, with general partners (GP) presiding over limited partners. The partners tend to be high net-worth individuals, public and private pension funds, endowments, foundations and sovereign wealth funds. According to PEI Media’s 2008 ranking of the top 50 private equity firms worldwide, the top four were United States-based. These were The Carlyle Group, Goldman Sachs Principal Investment Area, TPG Capital, and Kohlberg Kravis Roberts.
From obscure beginnings as boutique investment houses, through the junk bond leveraged buyout debacle of the 1980s, to the thousands in existence today, private equity firms have become an important source of capital. According to the trade industry association, Private Equity Growth Capital Council (PEGCC), in 2009, private equity firms raised close to $250 billion and made more than 900 transactions with a total value over $76 billion.
Private equity firms typically manage funds on behalf of their investors. They look for businesses with higher-than-average growth potential over the long term. They often provide senior management direction to the companies in which they invest. This is especially true in cases of majority control, because bigger returns mean bigger carried interest payouts for the GPS. Carried interest is the portion of the funds that remains with the firm after paying the limited partners and other investors their paid-in capital plus a minimum rate of return, known as the hurdle rate, and transaction expenses.
In 2009, private equity firms invested mainly in five sectors: business services, consumer products, healthcare, industrial products and services, and information technology.
The most common types of investment structures are leveraged buyouts, or LBOs; venture capital; growth capital and turnaround capital. LBOs use both equity and borrowed capital to invest in companies, hence the term "leveraged." Venture capital funds focus on new companies, mainly in the technology, biotechnology and green energy sectors. Growth capital invests in mature companies deemed to be undervalued. Turnaround capital, also known as distressed capital or vulture funds, looks for financially-troubled companies to buy inexpensively; potentially restructured, often through layoffs and asset sales; and then sold for a healthy profit.
It is difficult, from the outside, to judge the performance of a private equity firm. Unlike public companies that trade on the stock exchanges, subject to regulatory disclosure requirements, private equity firms do not typically disclose their financial statements. Private equity firms that trade publicly, like Kohlberg Kravis Roberts, do provide information on realized and unrealized profits from their investments. The realized profits are significant. According to PEGCC, through 2009, private equity firms have returned close to $400 billion in cumulative net profits to their investors.
With consolidation, private equity firms are getting bigger, investing larger amounts all over the world, and employing multiple investment strategies. After the financial crisis of 2008, the lavish payouts and secretive nature of these firms were under the media and regulatory spotlight. Disclosure requirements and other regulations are under consideration in the U.S. and Europe, with some already in place.