The Role of the Private Equity Firm

These investors don't want to manage these big-value, big-return investments themselves. Indeed, CalPERS is outstanding at managing money and making sure millions of California retirees get their checks each month, no matter the market conditions. But do they have the expertise to find a good company to buy, run that company, and then bring it public or sell it? That's where the private equity firms--and you, potentially--come in.

A private equity firm plays multiple roles throughout a typical investment. For example:

Raising the fund.

The private equity firm serves as a focal point for private capital. The firm raises capital from the various constituencies mentioned above, and then manages that capital appropriately until an investment is identified. In addition, the same people who raise capital also help obtain credit for any leverage needed for a buyout. Finally, they manage payouts to all involved.

Finding a target.

Firms employ researchers whose job it is to analyze the operations of thousands of companies, looking for potential investments. Sometimes it's easy--many companies readily announce they're looking at "strategic options," business-speak for putting themselves up for sale. But there are plenty of opportunities at other companies as well, even ones that seem to be operating just fine. The researchers know the strengths of the private equity firm's various management teams, and can identify potential targets based on the firm's ability to generate even more profits from their strengths. And in still other cases, a fund may simply see a very conservative company underutilizing its resources--a chain of casual dining restaurants, for example, that hasn't leveraged the real estate it owns to the degree it could in order to expand. There are plenty of ways to find a target--but that's a whole other discussion.

Closing the deal.

The fund must then approach the company--or, in some cases, manage a company's approach to it--and try to make a deal. This is very much like the merger-and-acquisition dance two publicly traded companies might make. The private equity firm generally hires a Wall Street investment bank for its advisory business, though its own cadre of dealmakers and due-diligence teams are often just as talented as those of the advisory firm. A deal is hammered out that usually gives the company's current shareholders a premium over the stock's current price, while giving the private equity firm enough room to make an even more impressive profit down the road.

Running the company.

Once a private equity firm buys a company, the deal generally fades from the news, but the hard work is just beginning. The firm, which represents the new owners, has a plan for maximizing profits ready to go--that was part of the targeting and acquisition process. The firm then brings in the individuals it thinks can execute that plan. Such plans often include a wide variety of cost-cutting measures, including new management and production processes as well as layoffs. It also typically includes borrowing quite a bit of money--generally far more than investors in a publicly traded company would stand for. As a rule, private equity firms are aggressive managers, and the leverage is put to work immediately. In recent years, that leverage has also served to give the fund's investors an early payout--essentially using the company's good name to sell bonds, the proceeds of which are then distributed to the new owners. One of the biggest debates about private equity is whether such debt is justified or even ethical, but when a company goes into private hands, there's little regulators can do.

The exit strategy.

There are a number of ways to unwind an equity investment and collect the profits. One is to sell the company to another entity, generally to an already-established company that was identified as a possible buyer early on in the due-diligence process. The private equity firm has done all of the hard work, after all, making it more attractive for a major corporation to buy. Alternatively, there are some companies that are simply bought for parts--there was speculation that Toys "R" Us would've been a much more profitable investment if its private equity buyers simply closed down the struggling toy retail business and sold all of its properties off. Finally and most notably, the private equity firm "flips" the company, returning it to the public equity markets through an initial public offering. In general, the company has to be stronger than it was when purchased for the private equity investors to get a good return, though in some cases--notably the Hertz IPO--the companies can be overloaded with debt. The private investors generally receive the proceeds of the IPO, though in some cases at least part of the proceeds will go to the company itself.

Naturally, when dealing with billions of dollars and major corporations, private equity firms need a wide variety of talented employees. And that's where you'll come in. Private equity firms employ some of the most experienced talent in corporate America, and their personnel needs are as broad as they are deep. Whether you're fresh out of undergrad or a seasoned corporate veteran, chances are you can find a home with private equity firms. And in doing so, you'll have a hand in making billions for your investors while guiding large corporations, and the thousands of people they employ, through major changes and improvements.