Common myths surrounding Private Equity

Whether you're a weary business owner or just someone interested in finance, many people have heard of PE. What you have likely heard is about large PE firms buying out an owner and systematically dismantling his/her company. However, this is usually a very very rare occurrence and has now painted a bad picture of the PE industry. Thus, most of what you have
probably heard regarding PE is likely false, and is a very generalized view of a diverse industry.

Firstly, in order to know why PE firms have done this you must know how PE firms operate and invest. The majority of PE firms (if not all) are set up as partnerships in which the firm has LP’s (limited partners) and GP’s (general partners). LP’s are commonly referred to as outside
investors, while the general partners usually operate within the firm. For this reason, PE firms like any other investment firm (or company for that matter) are worried about making money for
their stakeholders. Thus, many PE firms will use metrics and financial models to insure the companies they buy or invest in will provide a good return on capital once bought.

Like any industry, PE has small niche firms. Some of these smaller firms may solely look at struggling companies, while others may only look at small - mid market companies. For the firms that invest in failing companies, sometimes if the firm cannot turn the company around it will sell the assets of the business, and pay off its debtors to try and recoup some of its initial investment. Some of these firms may also separate the business from its land to recoup some of the investment if things go south. However, since this is a risky model, many PE firms prefer to only buy companies that are in good health and show steady signs of growth. For these companies, growing the business to its full potential as quickly as possible is their only concern.

You may say “if this is true then why have I heard so many bad things about PE,” to this I say
read on.

Myth #1: Private equity firms are ruthless takeover specialists.

Without a doubt the most commonly believed myth of all. Books and movies composed around the heyday of private equity (1980’s) such as “Barbarians at the Gate” have deeply contributed
to this viewpoint and portrayed it as a reality. However, currently this is largely not the case as many companies are far more valuable after a buyout. PE firms work relentlessly to improve the operations and products of the business they brought. Some firms may fire the CEO if he's consistently not performing up to par, and If they feel there are far too many employees in a department they may cut some of the staff to re-invest in more crucial areas. However, these expectations were likely set and agreed upon before the buyout. All-in-all if the business doesn't succeed and grow the PE firms don't make money.

Myth #2: PE is only interested in big buyouts.

Again there are plenty of PE firms that only dabble in large Buyouts, but there are also many firms that only invest in the small-mid market area. So this one is mostly false. PE firms only
invest when they stand to make money, whether that be a small buyout or a large one.

Myth #3: PE firms are only interested in Companies that are failing.

This one is also false as there is a small niche group of PE firms that specialize in this field, many PE firms will only buy healthy profitable companies that show strong signs of growth.

Myth #4: PE firms will only focus on finding an exit strategy for your company.

When a PE firm buys or invests in your company, eventually they will sell their interests in the business (usually around 5-7 years). This is predominantly due to the fact that PE firms must
provide liquidity for their LP’s (limited partners). If PE firms were to hold said companies, investors wouldn't be able to realise their returns. However, as stated above, PE firms have the
same goal in mind as you, to grow and expand the business as quick as possible.

Myth #5: PE investors don’t add value because they haven’t been in an operating role.

This may be true in some cases, but should be avoided as a broad generalization. Many times investors who do not have direct operating experience, have backed different companies at
different growth stages and can recognize common patterns associated with said stages. Furthermore, many PE investors have vast networks that can assist companies in numerous
ways such as strategic development and talent recruitment. Not to mention a fresh set of eyes can offer valuable perspectives that management may have overlooked.

Myth #6: PE-backed companies have a higher rate of failure

This one is also false, as PE firms only invest when they are able to make money and control their risks. Some niche PE firms that specialize in rehabbing failing businesses may have higher
rates of failure than traditional firms. However, it could be argued that this is due to the nature of the niche (far more risk when company is close to failing). All-in-all, PE firms offer liquidity and exit options for business owners seeking to retire or step down from business operations. Many times this is much easier and cheaper than taking the company public and or other forms of business liquidation and should be strongly considered

                                          Jarrod Mautz, Private Equity Intern