Posted: October 20, 2020
Though private equity is a commonly uttered phrase and one that most people have heard before, it isn’t always understood. Firstly, it refers to capital investment made into non publicly traded companies. So, when firms or individuals purchase stakes in a private company, that creates private equity. Influence or control can be asserted as a result of these direct and often very large investments which may represent a majority of the target company. This working capital can be used to restructure aspects of the company or management, develop new product lines, or simple help with business expansion. Sometimes, the restructuring of private firms and the subsequent reselling, will involve cost cutting which encourages short-term profit. This profit does not always lead to long-term growth and can cause future issues within the company. There are also many instances in which companies are taken private by private equity firms, grown and usually restructured, then sold or taken public to generate equity returns. Like many other types of investment, private equity investments seek to earn shareholders wonderful returns, usually in a 5-10 year period. Wealthy angel investors or firms with deep pockets stand to gain substantial amounts. When private equity focuses on startup companies rather than ongoing businesses, it is referred to as venture capital. A leveraged buyout (LBO) is one of the most common private equity investment strategies. It relies on the acquisition of a private company by way of a significant amount of borrowed funds. Often the borrowed capital will represent 80% or 90% of the total capital, while equity may be as low as 10%. The acquired company’s cash flow is then used by private equity firms to pay down the debt accrued for the purchase. When calculating the debt that can be paid down while considering acquisition, private equity firms will commonly look at a 5-year forecast for debt allocation. LBOs are sometimes regarded as predatory, as they can take advantage of a target business’ success by using its assets as collateral when borrowing the necessary capital for a buyout. When it comes to private equity compensation, how is it structured? Compared to other pay structures, private equity compensation structures are considered to be more difficult to fully grasp. Firms are paid by carried interest as well as management fees. The carried interest refers to a percentage of the profits received by a private equity firm after the reselling of a company. The bigger the profit after restructuring and reselling, the more the private equity firm makes. The private equity firm management fees are paid by investors (Limited Partners) on an annual basis as a percentage of the total investment given to the firm. These management fees may change or scale down after designated durations. Sometimes there are “deal fees” as well that are charged during each acquisition to cover extra firm expenses. Private equity firms pay base salaries and bonuses to their employees similar to other corporate roles. Often these can be covered by the reliable management fees and deal fees paid to private equity firms. More senior employees tend to make higher bonuses than junior employees who tend to receive equal parts salary to bonus. To learn more about maximizing executive salary, visit our Contact Page, or contact us directly by email at email@example.com or by phone at 415-618-6060.