Private Equity firms buy businesses the way individuals purchase houses – with a down payment or deposit supported by mortgage finance. A critical difference between how an individual purchases a home and how a Private Equity fund purchases a portfolio company, however, is that homeowners pay their own mortgages, whereas Private Equity firms require the companies they buy to assume the debt and pay it off. In the early 90’s, the P/E fund’s down payment or equity investment was typically 10% of the purchase price while 90% was borrowed.
Private Equity owners sit on boards, frequently visit their portfolio companies, and educate management on value metrics and the importance of future cash flow. Because the reporting is direct and focused on issues of corporate value, the Private Equity owner/investors spend more time finding creative ways to enhance the value of their investee companies.
They may transfer executives among portfolio companies. They may recommend proven operations or marketing consultants. In some cases, the Private Equity group may buy a company because it already has on board a talented and experienced executive team whom they hope to build a successful business. They find ways to get people to work toward the same goals, despite enormous difficulties and ideological differences.
P/E players focus on a three- to eight-year value building horizon. They are acutely aware of short-term results, but they target on long-term value. Typically when a firm acquires a new company, they are thinking 10 years until they get their ROI.
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