What Do Private Equity Firms Do & What It Means for Employees
Jul 19, 2021
Private equity firms are behind many of the largest and most visible private companies operating today. Anyone interested in selling a valuable business might attract the interest of a private equity firm.
Selling your business to a private equity firm is slightly different than selling to an individual or another company. It’s natural for business owners to want to ensure the best outcome for the employees and managers they have worked with for years.
How Private Equity Firms Work
First, a private equity firm pools capital from investors and forms a private equity fund. Once it meets a specific fundraising threshold, it closes the fund and begins investing that money into promising companies that fit its defined niche or strategy.
In many cases, business investors will target companies that have growth potential but are financially constrained or risk averse. Investment allows the company to accomplish its near-term financial goals and successfully grow into its potential.
Types of Private Equity Firms and Strategies
There are three broad categories of private equity investors: Angel investors, venture capital firms, and private equity firms.
- Angel investors make relatively small investments in early stage businesses and startups. They don’t usually take a controlling stake in the company, preferring to let the business grow on its own. These businesses may not have a proven profit model or any revenue at all yet.
- Venture capital firms also invest in young businesses and startups, but a little later in the life cycle than angel investors do. Venture capital investment typically favors businesses that lack the resources to scale up a proven profit model.
- Private equity firms focus on mature businesses that are already generating a profit. It is common for private equity firms to buy a controlling stake in the business, but minority positions are also common in certain cases.
How Private Equity Firms Make Money
Private equity firms invest money in mature businesses in traditional industries in exchange for an ownership stake – also called equity – in that company. Private equity firms invest in businesses with the goal of increasing the value of the business over time and eventually selling that business.
In order to increase the value of a business over time, private equity firms typically prefer a majority stake in the companies they acquire, but will often invest in minority interests as well. This allows them to direct the strategy and path towards growth alongside management to achieve a common goal of a more profitable and valuable business.
The private equity investment firm itself makes money by collecting carried interest. This is the payment fund managers receive over and above the required return for investors for creating value in the portfolio. Investors in the fund look to private equity fund managers to make smart, sound investments that grow over time and produce positive returns for everyone..
What Happens to Employees When a Private Equity Firm Buys a Company?
Business owners and managers want the best for their employees after a private equity firm acquires their company. Private equity investors’ focus on increasing company profitability often makes leadership unnecessarily anxious about job security.
But this perspective is oversimplified at best and manipulatively untrue at worst. Private Equity firms generally find the value that attracted them to a business lies largely within its employees. Private equity firms don’t “win” by driving companies into bankruptcy or firing all of the employees. They earn money by guiding companies towards success – and no company can succeed without its employees.
The best private equity firms increase company value by leveraging employee talent and improving the productivity of every hour worked.
How Private Equity Creates Value
Private equity investment creates value over a long time frame. Most firms exclusively invest in companies in industries in which they have operational knowledge. The combination of capital resources and years of experience creates ideal conditions for company growth.
The process of taking a company and turning it into a successful, well-established business can take years. The best private equity firms employ experts who know exactly how to achieve these results for the companies in their portfolios.
Often, this means gaining efficiencies through cost control, boosting profits through price improvement, and identifying opportunities to capture more of the market. According to a 2019 McKinsey report, price improvement is one of the greatest growth opportunities private equity acquisitions enjoy, driving average profit gains almost six times higher than reducing fixed costs (like salaries).
Working for a Company Owned by Private Equity Is an Opportunity
When reputable private equity firms invest in companies, it makes a pledge to turn that company into a sustainable, growth-oriented organization. Employees who are part of that growth will earn their share of its rewards because they are the ones responsible for seeing it through.