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Most New Jersey business owners have heard the term private equity but are not really aware of what it is or how it works.
Private equity is capital that has been pooled, generally by wealthy individuals, that is invested in privately owned companies that are believed to have the potential for rapid expansion and profit growth. The individuals involved in private equity are almost always accredited investors. Private equity is also often used to take publicly owned businesses “private”, but let’s concentrate here on the business that is privately owned. In the recent past, the focus of private equity firms has been on companies with EBITDA (earnings before interest, taxes, depreciation and amortization) of $1 million or more but presently many firms are considering investment opportunities in firms with EBITDA of $500,000 or more and in some cases less, depending upon growth prospects.
The article below is from Investopedia and gives an excellent overview of how private equity works.
Private equity is capital that is not noted on a public exchange. Private equity is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies, resulting in the delisting of public equity. Institutional and retail investors provide the capital for private equity, and the capital can be utilized to fund new technology, make acquisitions, expand working capital, and to bolster and solidify a balance sheet.
BREAKING DOWN Private Equity
Private equity comes primarily from institutional investors and accredited investors, who can dedicate substantial sums of money for extended time periods. In most cases, considerably long holding periods are often required for private equity investments, in order to ensure a turnaround for distressed companies or to enable liquidity events such as an initial public offering (IPO) or a sale to a public company. Since the 1970s, the private equity market has strengthened readily. Pools of funds are sometimes created by private equity firms in order to privatize extra-large companies. A significant number of private equity firms perform actions known as leveraged buyouts (LBOs). Through LBOs, substantial amounts of money are provided in order to finance large purchases. After this transaction, private equity firms attempt to improve the prospects, profits and overall financial health of the company, with the ultimate goal being a resale of the company to a different firm or cashing out through an IPO.
Fees and Profits
The fee structure for private equity firms typically varies, but usually includes a management fee and a performance fee. Certain firms charge a 2% management fee annually on managed assets and require 20% of the profits gained from the sale of a company.
Positions in a private equity firm are highly sought after, and for good reason. For example, consider a firm has $1 billion in assets under management (AUM). This firm, like the majority of private equity firms, is likely to have no more than two dozen investment professionals. The 20% of gross profits generates millions in firm fees, so some of the leading players in the investment industry are attracted to positions in such firms. At a mid-market level of $50 million to $500 million in deal values, associate positions are likely to bring a salary in the low six figures. A vice president at such a firm would stand to earn something close to $500,000, while a principal could earn more than $1 million.
Beginning in 2015, a call was issued for more transparency in the private equity industry, due largely to the amount of income, earnings and sky-high salaries earned by employees at nearly all private equity firms. As of 2016, a limited number of states have pushed for bills and regulations allowing for a bigger window into the inner workings of private equity firms. However, lawmakers on Capitol Hill are pushing back, asking for limitations on the Securities and Exchange Commission’s (SEC) access to information.
If you have a company that you believe could be expanded rapidly, you may be a candidate for private equity, even if you are not currently profitable. Crown Business Brokers LLC has contacts in the private equity community, so please feel free to give us a call at (908) 364-6920, or email us at email@example.com.
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