Understanding the way Private Equity Funds Work

What is a private equity fund? A private equity fund is established when investors put together large sums of cash. The investors use the cash to invest only in private companies. They can also use the funds to buy companies. This type of fund is managed by a private equity fund manager. The manager will charge the investors a fee for his services. Investors buy private equity funds to make money quickly. There is almost no government intervention when dealing with private equity funds as opposed to public equity funds. Most private equity funds are composed of venture capital funds or leverage buyout funds. According to the University of Chicago Graduate School of Business, most private equity funds are operated by institutions and wealthy individuals.

Venture capital funds are used to help start a business. There are many individuals that do not have  cash to start a business. Banks will not lend money to most entrepreneur’s because most small start-up businesses have a very high failure rate. Therefore, entrepreneur’s turn to private sector venture capital firms for start-up cash. For example, Google was started by venture capital funds. The young men had a brilliant idea but they had no cash on hand. They received cash from several venture capital firms and now the company has thousands of workers. This is how private equity funds work. Read this article from the Yale Law School News website entitled, How Private Equity Works- A Commentary by Jonathan Macey ’82. The republican presidential candidate Mitt Romney spent most of his career working in the private equity industry. The leverage buyout process is different.

Leverage buyout process is more difficult because the equity funds are used to invest in a mature company instead of a start-up company. There are many small businesses all across America that need cash. A company may need cash to improve its products or its services. Simply put, there are also businesses that have piles of debt. The leverage buyout allows the private companies to have access to cash with strings attached. For instance, a small trucking company needs to buy five new trucks to stay in business. A leverage buyout agreement may give the investors a percentage of the company profits. The owners stay in business and jobs are saved. However, not all venture capital and leverage agreements seem to be fair. The Stanford University states that worldwide private equity funds manage about $1 trillion dollars in a report by Andrew Metrick at Yale School of Management and Ayako Yasuda at the University of California, Davis.

Keep in mind that private equity fund investors only want to make money. John Donvan, had a very interesting discussion about private equity funds entitled, ‘Vulture Capitalism’? How Private Equity Firms Work. This may also mean that workers will be laid-off or even fired. When a business is failing, the owners are in a bad situation if they need cash. The investors can take over the company and restructure the company. They can also charge the company higher fees. There have been thousands of jobs lost due to leverage buyouts. Today, we are hearing the term “Vulture Capitalism” when things seems unfair. This is how capitalism works and this is how private equity funds work.