Private Equity
Private equity refers to stakes in companies that are not traded on the stock exchange. Specialized funds buy such companies in whole or in part, transform them over a few years, and later sell them on at a profit.
Anyone can buy shares in large companies like VW or Siemens on the stock exchange. Most companies, however, are not listed on the stock exchange at all. Their shares only change hands when a buyer and a seller reach a direct agreement. This is exactly the area in which private equity operates, meaning roughly “private ownership capital”. The term refers to investment firms that buy up such non-listed companies. They usually hold the company for four to seven years, try to increase its value, and then sell it on.
Who owns the companies behind the companies
Private equity has long since ceased to be a niche phenomenon. Worldwide, such funds manage several trillion euros. In Germany, thousands of mid-sized companies are wholly or partly owned by private equity firms. When a well-known brand suddenly changes owners, a private equity fund is often behind it.
For companies, this can be an advantage. A family business without a successor can find a buyer this way. A young company gets money for growth without the costly process of going public. And a corporation can offload a division that no longer fits its core business.
Nonetheless, there is plenty of criticism. Because the funds want to sell their stakes again after just a few years, rapid value growth takes priority. Critics accuse the industry of cutting costs, cutting jobs, and burdening companies with debt. Proponents counter that this is precisely what makes sluggish companies competitive in the first place. Both occur in practice, depending on the fund and the situation.
Buy, restructure, resell
A private equity fund first raises money. It comes from pension funds, insurers, foundations, and very wealthy private individuals. This capital is locked in for ten years or longer; unlike with stocks, you cannot exit at short notice. The fund then uses the money to buy several companies.
Typically, only part of the purchase price comes from the fund’s own money. The fund borrows the rest from banks. This debt is loaded onto the acquired company, which must pay it off out of its profits. This is called a leveraged buyout, meaning a purchase using leverage. The leverage works in both directions: if things go well, the fund’s profit multiplies. If things go badly, the interest burden crushes the company.
During the holding period, the new owners intervene actively. They replace management, buy up competitors, or sell off unprofitable divisions. At the end comes the departure, known in industry jargon as the exit. The company goes to a corporation, to another fund, or onto the stock exchange.
Private equity in tech news
The term comes up especially often in the technology sector. Software and IT service providers are considered attractive targets because their customers have long-term contracts and pay regularly. Such predictable revenue makes it easier to service loans. Major acquisitions of software companies by funds like Blackstone, KKR, or Thoma Bravo regularly reach double-digit billion-dollar amounts.
It is important to distinguish this from venture capital, the risk capital for start-ups. Venture capital finances young companies that are not yet profitable, accepting that many of them will fail. Private equity, by contrast, usually buys established companies with a stable business. Both are forms of investment outside the stock exchange, but the risks involved are completely different.
A private investor can hardly invest directly in classic private equity funds, as the minimum amounts are often in the millions. Indirectly, almost everyone is affected: pension funds and life insurers invest part of their money there. So anyone with an occupational pension probably holds indirect stakes in companies they have never heard of.