Source: PEGH
Editor: Briac Mbezele
What Do Private Equity Firms Do?
Private equity represents a form of investing where funds or companies put money directly into private businesses or buy public companies to take them private. Unlike stock market investing, private equity operates behind the scenes, with specialized firms managing money pooled from pension funds, insurance companies, and wealthy individuals.
The strategy is straightforward but powerful: buy promising companies, improve them, and sell at a profit years later. What sets private equity apart is its hands-on approach. These investors don’t just provide capital, they actively work to increase company value through management changes, operational improvements, or expansion strategies. They might streamline processes, upgrade technology, enter new markets, or even combine businesses to create stronger entities.
Private equity investments typically last 3-10 years before the investors exit through various means. They might take the company public through an Initial Public Offering (IPO), sell to another business, or transfer ownership to another investment firm. Throughout this process, private equity firms leverage their business expertise, industry connections, and financial resources to help companies reach their full potential. These investments serve an important economic purpose by providing both funding and expertise to businesses that may not have access to traditional financing. While private equity sometimes faces criticism for aggressive cost-cutting or using significant debt, it has become a vital source of transformation capital in today’s business landscape. By helping companies innovate, expand, and become more competitive, private equity contributes to job creation, technological advancement, and broader economic growth.
Understanding Leveraged Buyouts: The House Example
Source: CheckaTrade
Most people buy homes with a down payment and a mortgage for the rest. Private equity firms use this same approach when buying companies, calling it a leveraged buyout (LBO).
Here’s how it works: If you want a $500,000 house but only have $100,000 saved, you put down your savings and borrow $400,000 from the bank. The bank feels comfortable with this arrangement because the house itself serves as collateral for the loan.
Private equity firms follow this exact model, but with businesses instead of houses. They typically put down 20-30% of a company’s purchase price and borrow the rest. The loans are secured by the company’s assets and future earning potential.
Just as you might renovate your kitchen or add a bathroom to increase your home’s value, private equity firms improve their companies by cutting unnecessary costs, bringing in better management, expanding product lines, or entering new markets.
When you eventually sell your renovated house for more than you paid, you pocket the profit after paying off your mortgage. Similarly, when private equity firms sell their improved companies, they repay their loans and keep the gains, often much larger than if they had used only their own money for the purchase in the first place.
Blackstone's Hilton Success: A Private Equity Win
Source: Wealth Club
In 2007, Blackstone Group bought Hilton Hotels for $26 billion, paying 40% more than its market value. They used some of their own money but mostly borrowed funds, a typical private equity approach.
Though Hilton was already big with nearly 3,000 hotels worldwide, it wasn’t running as efficiently as it could. Blackstone saw this as an opportunity to make improvements.
After taking over, Blackstone worked with Hilton’s management to streamline operations, expand globally (especially in Asia), update hotel properties, and improve technology systems. These changes made a huge difference.
Six years later, Blackstone took Hilton public again at nearly double the value they paid. Eventually, they sold all their shares for a $14 billion profit, one of private equity’s biggest success stories ever.
This deal shows how private equity firms can transform companies by combining money, expertise, and strategic improvements to create significant value.
