We’re kicking off the new year looking at private equity.
If you’d like to extend your equity investing beyond public stocks, ETFs and mutual funds, PE can be a rewarding alternative.
We’ll dive into the history, how it works why it’s controversial, recent performance, how it’s changing, and how you can invest.
Note: The first half of this issue is free. But you’ll need the All-Access Pass to read the full thing.
Let’s go 🥂
Jeffrey Briskin is a veteran Boston-area financial writer and marketing consultant. His past work with Alts include deep dives on Sensate, Geoship, and most recently the market for pinball machines. Jeffrey is also the author of the best-selling Biblical crime novel, Bethlehem Boys.
Table of Contents
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This issue is sponsored by Arta Finance Wealth Management LLC. Alts.co is not a client of Arta and has been provided cash compensation for the endorsement. The opinions expressed are based on the author’s knowledge of Arta’s services and are not indicative of future results. This issue is for informational purposes only and should not be considered investment advice or a recommendation to buy or sell any particular security.
What is private equity?
Private equity investing gives you ownership in privately owned companies of all sizes — from startups, to established retail chains, to healthcare networks that employ thousands.
Here’s the thing: Most of these companies will never trade on the stock market. And that’s okay! This can actually be a bonus for investors, because the value of privately held companies isn’t impacted by the whims of Wall Street.
It’s rarely discussed, but the number of public companies in the US has been steadily shrinking since 1996. Today there are just 4,300 American public companies, compared to 27 million private ones.
You’ve got more opportunities to choose from than ever, and there are a variety of ways to invest. This is just one reason savvy investors include PE in their investment portfolios.
Other reasons:
- To take a more direct stake in funding companies in industries that interest them.
- To help revitalize struggling companies that need an influx of capital to turn their fortunes around.
- To get a deeper level of diversification that can potentially protect against losses in bear markets.
A short history of American private equity
If you think about it, private equity investing went a long way toward making the US what it is today.
It can all be traced back to the nation’s origins in 1620. Not long after the Pilgrims settled in Plymouth, Massachusetts, British investors established the Massachusetts Bay Company, whose mission was to fund the development of the colony.
In fact, private investors have been predominantly responsible for funding most of America’s expansion; from providing capital to struggling railroads, to the nation’s first mega takeover effort, when JP Morgan bought Carnegie Steel in 1901, creating what would eventually become the world’s largest company — US Steel.
Note: There are five American PE firms with a strong history of investing in steel. Get the All-Access Pass to learn more.
Most economic historians agree that the first firms created solely to invest in and take over private companies were in 1946:
- American Research and Development Corporation (ARDC) which was founded by Georges Doriot and essentially created the venture capital industry. It ceased operations in the 80s.
- J.H. Whitney & Co., which is still around today
The growth of PE firms started off relatively slow. In 1980, there were just 28 private equity firms. But by 2020, that number had exploded to over 4,500!
As of 2022, PE firms managed around $11.7 trillion in assets — about 4x larger than the entire cryptocurrency market.
How does private equity operate?
PE firms operate differently depending on their investment mandate.
Let’s take a look at the most popular strategies.
Leveraged buyouts
Leveraged buyouts (LBOs) are the infamous PE plays that many people have heard about.
In a leveraged buyout, a PE firm uses massive amounts of debt financing to buy a majority stake in a troubled company, with the goal of improving their fortunes.
It seems complex, but it’s basically just uising borrowed money to acquire and enhance a company’s value.
How it works:
- Investors provide the debt financing capital
- If the company is public, it is typically taken private (delisted from stock exchanges).
- The acquired company is typically restructured & optimized for efficiency (i.e. layoffs), and positioned for a sale or IPO.
- Once the loan is paid off, cash flows are used to pay back/distribute profits to investors
Critics often accuse PE firms of saddling takeover targets with the responsibility of paying off the loans the PE firm amassed to buy the company.
Faced with often-insurmountable debt, the companies often have to make massive layoffs or trim costs to the bone to free up capital to make these payments.
This video explains the controversial concept (known as asset stripping):
LBOs can be performed on either private or public companies. But in recent years, private company LBOs have become more common than public company LBOs
From Preqin Global Private Equity Report 2024:
- Private Company LBOs represent approximately 70–80% of global LBO transactions annually ($350 billion)
- Public Company LBOs make up about 20–30% of transactions but often involve larger deal sizes ($150 billion)
A textbook example is PE firm KKR’s leveraged buyout of RJR Nabisco, Inc., one of America’s largest manufacturer of food and tobacco products, a story that was chronicled in the best-selling book Barbarians at the Gate.
In 1989, RJR Nabisco’s CEO, Ross Johnson, wanted to take the company private to overcome its steadily falling stock price. A bidding war ensued, after which KKR emerged victorious with a $25 billion bid financed by the largest LBO in history.
However, KKR saddled RJR Nabisco with so much debt that the company had to use most of its meager cash flows to make interest payments, rather than diversify its product line! The company gradually began selling off its various divisions to pay down debts before going public in 1991.
The company never overcame its problems, and the combined entity was dissolved in 1999.
However, for every LBO debacle, there are numerous positive examples of PE firms using LBOs to rescue struggling firms. Noted examples include:
- In the late 1980s, KKR used an LBO to acquire the Safeway — a struggling supermarket chain, which had been fending off a hostile takeover. After the deal was completed. Safeway restructured its operations and became profitable again.
- In 2007, on the eve of the Great Recession, Blackstone acquired the privately owned Hilton Hotel chain through an LBO. This actually triggered a US Department of Justice investigation, which both companies survived. By 2013, when Hilton went public, its value soared to $12 billion.
- In 2013, Silver Lake Partners used an LBO to help Dell Computer repurchase its publicly traded stock and become a private company with billions of dollars in assets. This move enabled Dell to shed underperforming businesses and return to profitability.
Growth equity investing
PE firms often become silent partners in promising startups or established private companies.
This is basically just standard VC-style growth capital. Investors provide capital for established companies that want to expand their footprint or restructure their business to boost revenue and profitability.
Growth equity investors generally aren’t trying to take control — they’re happy to receive a minority stake that entitles them to a big payoff if the company goes public, or a share of a company’s future profits.
A textbook example is Silver Lake Partners’ investment in Alibaba. Its stake helped the Chinese ecommerce company issue an IPO that netted $4.5 billion in paper gains for Silver Lake.
Another example is Silver Lake and Sixth Street Partners’ $1 billion investment in Airbnb at the beginning of the COVID-19 pandemic, which paid off handsomely when the company went public in December 2020.
Carve-outs
Carve-out transactions occur when either a public or private company sells a non-core business or asset to a PE firm.
Carve-outs enable PE firms to add greater diversification to their portfolios and gain hands-on management experience in new sectors.
Examples of noteworthy carve-outs funded by PE firms include:
- Kraft Heinz’s spinoff of its cheese manufacturing subsidiary
- Coty’s carveout of its retail hair business
- BP‘s divestiture of its petrochemical holdings
Distressed assets
Some PE firms focus on companies that may be on the verge of bankruptcy or dissolution.
These companies may still have valuable assets, such as real estate or a retail brand that no longer works in a brick-and-mortar setting but might still work online.
The Sharper Image and Pier 1 Imports are examples of two firms that sold ownership of their physical assets with the help of PE firms.
What’s the state of PE today?
🔑 Unlock the full issue to learn:
- Top-performing funds
- Top performing sectors
- Deal activity & sentiment
- The most important PE trends
- How to invest in private equity yourself
👉 Unlock the full issue with the All-Access Pass to dive deeper into this world.