Private equity, in theory, is the strategy of pooling capital to invest in often struggling companies with the hope of turning them around while collecting a check in the process.
Up until now, investing in such funds has only been available to individuals with a $1 million net worth or an annual salary of $200,000 for the past two years.
The returns on these strategies have far exceeded that of the S&P 500, often seen as the benchmark. Between the years 2008 and 2018, returns on these funds have averaged around 14% annually whereas the S&P 500 has an average annualized return of 7.3%. It’s not hard to see why the wealthy invest in these funds — the higher the risk, the higher the reward.
Inversely, these funds, when managed incorrectly can give away terrible losses to those involved. According to McKinsey & Company, subpar equity funds have returned losses of 30%, whereas a subpar mutual fund or Exchange Traded Fund can result in a gain of 7%.
In a recent proposal, the Securities and Exchange Commission has asked the public if they would like the opportunity to invest in private equity funds.
It is expected that the regulator will ease restrictions, allowing everyday investors to put their money in these funds.
With this unveiling comes a slew of challenges for managers of these private equity funds. In many cases, deals made through these firms are long-term commitments that do not allow investors to pull their money out.
If a sheepish investor were to get involved and panic, it could mean the collapse of the deal. This is why the industry is considered highly illiquid, as the money is tied up in long-term deals.
One other such problem is the issue of leverage. For a fund to buy a company, it needs large infusions of cash.
These often come in the form of debt. In fact, this is why the process of buying up a company via a private equity firm is called a leveraged buyout.
In the heyday of LBOs, in the 80s and 90s, firms would finance their purchases with debt up to 90% of the purchase price. Taking on a ton of debt, seen as a standard on Wall Street, may spook many investors who are completely new to this world or might not completely understand it.
Despite all of these bells and whistles, some private equity deals have been successful.
For example, Dell Technologies Inc., a computer maker that went private in a $24 billion deal with Silver Lake Partners, became a public company again after a few years as a private corporation. Dell is now trading under the ticker symbol DELL on the New York Stock Exchange.
After the company was revived in the brief years it was private, it saw fit to enter the public light as a new and confident corporation.
On Nov. 6, Walgreens announced it was interested in going private through private equity firm Evercore.
If completed, it will be the world’s largest LBO, valued at around $55 billion. This comes hot on the heels of disappointing earnings and a series of bad deals. Most recently, Walgreens tried and failed to acquire Rite Aid, a deal that fell through because regulators were worried it would affect competition.
If Walgreens’ plans on going private, investors might very well see it going public again soon, as a fresh and confident corporation.
