WTF Does Private Equity Actually Do?

private Equity has minted more Global billionaires than oil and Technology it's a $4.7 trillion Global business that according to some Outlets has crushed your ability to buy a house and your chance to relive your childhood at Toys R Us private Equity is simultaneously the ultimate career goal of every insufferable business bro and the cause of all the world's problems but what the [ __ ] do these people actually do looks like this uh Hill path Capital which is a private Equity Firm has purchased the outstanding shares of SeaWorld in the intend on dis of dismantling

it and liquidating the company private Equity firms have been acquiring Physicians practices and medical operations at an increasing rate over the last decade private Equity is nothing more than any investment company that invests into assets that are not listed on public markets the variety of private Equity companies is enormous some private Equity firms will invest in very early startups and give them money to grow their business and acquire new customers these firms tend to go by the name Venture Capital but that's still a type of private Equity other private Equity companies focus on buying alternative

assets like airports toll roads intellectual property rights and carbon credits these firms offer liquidity to asset holders that would find it almost impossible to sell what they own without their services you can't put your North Dakota drilling rights on Facebook Marketplace and expect to find a buyer if something is worth money there will be a private Equity Firm that will try and make a deal out of it there are even private Equity firms that are called a fund of funds which you guessed it raises money to invest in to other private Equity Funds but when

you hear politicians journalists and angry people online talking about private Equity they are normally talking about the buyout funds if you can start and run a successful buyout fund there is a good chance you will become a billionaire because these firms are fine tuned to make the most amount of money possible from buying entire companies so if you wake up one day and decide to start a private Equity Firm specializing in corporate buyouts here is what you will actually need to do in Three Easy Steps step number one is before you even think about going

out to find your first investor or acquisition opportunity is to get your corporate structure right as a Savvy private Equity Fund manager your firm's legal setup is key It's Complicated by Design enabling you to minimize personal risk maximize personal gains and navigate complex Financial regulations effectively your strategic move is to form a Delaware limited partnership where you'll be the general partner the Delaware limited partnership is popular in private Equity due to its legal benefits and operational flexibility here you'll have the power to make critical investment decisions and manage day-to-day operations a crucial element of this

setup is the limited partner agreement or LPA the LPA is a contract that outlines the terms between you the general partner and your limited partners typically your investors the LPA details everything from investment strategies to distribution of profits and loss allocations it's the rule book that governs the partnership ensuring Clarity and structure in the relationship between you and your investors as the general partner the LPA empower ERS you to steer the funds Investments while outlining your responsibilities and the scope of your Authority balance and control with accountability this structure with its well-defined LPA provides a

stable framework for managing the fund offering protections for both General and limited partners if you have too much control nobody will want to invest their money into your fund and if you don't have enough control then you won't be able to run your fund effectively in the movie The Big Short Michael bur's character played by Christian Bale gets into an argument with one of his biggest investors who questions when other investors in the fund would be eligible to pull their money out my God Mike bu had made a very risky investment at this point in

the movie that most of his investors didn't agree with so if they could pull their money out they probably would but bur's firm had rules about withdrawal eligibility written into a mandate so they were stuck until bur's investment paid off had they been able to pull their money out early bu would have had to close his positions and everybody in the fund would have missed out on one of the greatest investment opportunities ever so this structure is essential to running your private Equity Fund effectively but you're not done yet you will also want to add

a management company that is technically separate from the firm but can give advice to the fund and the acquired companies this is the part of the business that is full of the Harvard MBA analyst that you will need to pay $250,000 a year before bonuses because they are the ones doing the math and due diligence on whether a company is a good investment or a bad one while you're at it you'll want to make yourself or a trusted business partner the chairman and CEO once you have the structure place it's finally ready to start shmoozing

investors and finding beloved companies to drive into bankruptcy so it's time to learn how money Works to find out what the [ __ ] private Equity firms actually do this week's lesson is sponsored by brilliant brilliant has now set a personal record as my longest consecutive subscription service and there's a good reason for that as the technological universe is getting much more complicated brilliant is helping me stay ahead of the curve understanding these important changes brilliant is the best way to learn math data science and computer science interactively whether you want to make a career

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in the description and the first 200 of you will get 20% off brilliant's annual premium subscription all you are really is a private Equity General partner is a middleman between investors and good Investments so the second step is the simplest part but also the hardest part as a head of a private Equity Firm you'll be taking money from investors and using it to make investments into private companies those investors can make the same Investments by themselves so you need to try hard to convince them that their money is better with you because you can make

them better returns even after after taking out your fees those fees are normally a 2 and 20 structure your firm will get 2% of all assets you have under management every year this 2% is used to pay the salaries of the expensive Harvard mbas working in your management company here so once they have been paid there won't be much left over for you but that's what the 20% is for 20% of all returns over a pre-agreed upon rate called the hurdle will be paid to you as an additional bonus if you agree with your investors

on an annual hurdle of 10% perom but your firm delivers 20% returns you get to keep 20% of those additional returns for yourself as the firm's General partner so there are some big incentives for you to make some big returns you also have an incentive to manage as much money as you can because it's better to get 20% of a bigger pie overall so one of your most important jobs is just getting people to invest with you the first step in raising money from investors is that you will need to put some of your own

money into the fund if you aren't already a billionaire your own money won't be enough to start acquiring whole companies but this still does two very important things the first thing is that it shows other investors that you are willing to put your money where your mouth is and that you will take good care of the fund because it's your money at stake too the second thing putting your own money into the fund does is create an exciting little tax loophole which means you are going to pay a lower tax rate than most Americans but

you will see how later once you have put your own money in you need to convince other people to trust you with their money which is why it's normally a good idea to start a private Equity Fund after you already have industry connections and experience if you don't have any of those connections just yet don't worry some investors will also give you money if you have a lot of experience in a particular industry so let's say you have owned and managed hotel chains before you can create a private Equity company that will just invest in

hotels and other Hospitality businesses the number one best way to attract more investors is to generate consistently High returns do this for long enough and you might even have so many investors that want to give you their money that you will have to start turning them away but for now you will have to start small with your first acquisition your team of analysts at your management company will work with investment bankers who act like reers for people looking to sell their companies your analysts are going to be looking for companies that generate profit with good

cash flow in a stable industry with improvements that can be made by your private Equity Firm to increase profitability since you have told your investors that your skills are in managing hotels your team will also need to look for deals that are in the hospitality industry buying a pharmaceutical company could violate the investment terms of your Limited partner agreement and you could get sued by your investors if you spent your entire career managing hotels you won't know [ __ ] about running a pharmaceutical company they also need to work with investment bankers to find companies

that want to sell at a decent price once a business is found the private Equity team will work with the investment bankers to draft an indication of interest and conduct due diligence on buying the company the private Equity team will also start talking to other investment bankers and private lenders to try and take out a loan to finance the deal if you're fir was only able to raise a pitiful $100 million from investors and the company you want to acquire is also worth $100 million you are risking your entire firm on one bet what you

need to do instead is show a bank that the company you want to acquire has stable profits and good operating cash flow so that you can get a loan for $90 million to finance the deal you can then use $10 million of your own money to perform a leverage buyout if you have only use $10 million you can also do these 10 more times before you have deployed all of your money the company's you acquire are called portfolio companies and your job now is to get as much money as possible out of them for your

investors private Equity firms have a bad reputation for gutting companies laying off staff and saddling them with tons of debt and that's because they do this a lot since you own the portfolio companies you can tell their CEOs what to do and if they don't listen you can just appoint your own CEOs that will do exactly what you and your management team tell them to do there are a few strategies that private Equity managers such as yourself like to employ to increase the returns of their portfolio companies one strategy is consolidating the operations of all

the companies in The Firm since you are investing in hotels you could merge the booking housekeeping staff Administration rewards points and Contracting all under one entity to save on overhead and offer a better overall product to customers but if that's too creative then you can always use your team of analysts to find the areas of the business to cut creative you don't even need to cut costs you can just use the company's profits to pay down the $90 million in debt and then sell the company even if you don't grow it it's kind of like

buying a house and having a renter pay down your mortgage for you this kind of Ivy League business advice doesn't come for free even though the management fee is considerably less than what you can get if you get a return on your investment it's still a lot of money once you have over a billion dollars worth of companies under management in your portfolio which brings us to the third and most important step of this whole operation getting paid by cutting expenses and improving business operations your portfolio of companies should now hopefully be worth more than

what you paid for them so now you need to turn those paper gains into Cold Hard Cash the easiest way to do this is to sell the companies at a profit to a buyer you can call up another investment bank and they will give you three options to sell your companies the first option is you could take your company's public through a spa or IPO and sell them to the general public the second option is to sell them to a strategic buyer like an even bigger Hotel chain that wants to acquire your portfolio through an

acquisition and the third option is you could sell it to another investor like another private Equity Fund or a family office that just wants to continue growing it there's one other important Point worth mentioning since the firm operates as a partnership and you as a general partner and considering you're investing your own Capital into the partnership profits can be distributed as capital gains instead of income long-term capital gains is taxed at a maximum rate of 20% in America which is a lot less than you would pay on millions of dollars in income any other way

this is called the carried interest loophole but it has nothing to do with interest rates at all the interest actually refers to the vested interest you have in the fund that you manage that doesn't mean you can ignore interest rates though as a private Equity manager you're going to take loans out to acquire new companies and a cash out of your positions so the whole operation is very sensitive to interest rate changes the stress of private Equity is actually one of the reasons that we are currently in the midst of a corporate bankruptcy boom but

to find out the other three reasons go and watch my video on why that was probably overdue anyway I'm going to be writing a similar guide on what you would actually do in private Equity as a more entry-level employee and how much you could expect to make in a job like that for fresh at a college that will be up this week on my completely free email newsletter so make sure you subscribe with the link below to keep on learning how money works