Question 1

What is private equity?

Accepted Answer

Private equity is the business of buying whole companies with other people's money, running them for three to seven years, and selling them for more than you paid. The money comes from limited partners, which in practice means public pensions, university endowments, insurance companies, and sovereign wealth funds. The general partner, the PE firm itself, charges a 2% management fee on committed capital and takes 20% of the profit above a hurdle rate. Private equity is private in the sense that the companies are not traded on a public exchange. It is not private in the sense of small. The biggest firms, Blackstone, KKR, Apollo, Carlyle, manage more than a trillion dollars each.

Question 2

How does a leveraged buyout work?

Accepted Answer

The fund puts up roughly a quarter of the purchase price in equity and borrows the rest. The loan does not sit on the fund's balance sheet. It sits on the acquired company's balance sheet, which means the company is now using its own cash flow to pay interest on the debt that was used to buy it. This is the central structural fact of an LBO and the source of both its returns and its risks. If cash flow stays stable, leverage amplifies equity returns. If cash flow dips, the interest payments do not, and you get a default. The whole question of whether an LBO works or fails is whether you bought a business stable enough to carry the debt.

Question 3

What is carried interest?

Accepted Answer

Carried interest is the 20% of fund profits the general partner keeps, on top of the annual management fee. The tax treatment is the famous part: for historical reasons, carried interest is taxed as a long-term capital gain rather than as ordinary income, which is why private equity partners pay a lower marginal rate than the dentist across the street. Every few years Congress announces it is going to close the loophole, and every few years Congress declines to close the loophole. The policy defense is that carried interest is compensation for taking investment risk. The policy critique is that the general partner is usually putting in a small fraction of the fund's own equity, which means the risk being taken is mostly the limited partners'.

Question 4

How does private equity affect employees?

Accepted Answer

The research is not ambiguous. Employment at PE-acquired firms falls on average in the first two years after the deal, and falls more sharply when the target was a public company taken private. Wages tend to lag. Benefits tend to get trimmed. Some of this is efficiency, and some of it is cash flow being diverted from payroll to interest payments. There are counterexamples, growth-oriented PE that adds headcount, but the central tendency is toward leaner staffing. If you work at a company that just got acquired by a fund, the next six to twelve months will include at least one headcount review, and the thing you are competing against is not your own performance but the fund's debt service schedule.

Question 5

What is the difference between private equity and venture capital?

Accepted Answer

Both are private, both charge the 2-and-20, both sell the asset eventually. The difference is where in the company's life they show up. Venture capital funds early, buying minority stakes in startups that do not yet make money and may never make money, betting that one winner in ten pays for the other nine. Private equity funds late, buying mature companies that already make money, using leverage to amplify returns on businesses the stock market has mispriced or ignored. VC underwrites growth. PE underwrites cash flow. VC's losses come from companies that never work. PE's losses come from companies that worked fine until the interest payment was due.

The private equity playbook.

A PE firm finds a company that looks undervalued.

Private equity, answered.

The private equity playbook.

A PE firm finds a company that looks undervalued.

Private equity, answered.

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