A short explainer (YouTube talk) defining private equity as buying whole companies, holding them multi-year, using leverage, and selling for a return. Core value drivers highlighted: predictability/sustainability of earnings (most important), banks' caution when lending leverage, and aligning incentives between owners/operators (active ownership but not day-to-day management). COVID-era examples are used to illustrate unpredictability risks.
Chapters
What is private equity? It is an investment approach that is about buying entire companies, holding them for three, four, five, six, seven years, selling the entire company, and then generally using leverage to do that. The goal of these firms is they invest equity upfront and then when they sell the business, they get a return on their equity. If nobody is willing to pay more for the business at the end than they bought it for, they don't make money. And that's a key driver in what they do. What are the key value? What determines whether someone like a business or like a business? The number one characteristic they look for is predictability of earnings, their plan. Owning a business for multiple years, using a lot of leverage to buy it. They only get paid if this business is worth more in the future than it is right now. Their conviction and research around the predictability sustainability of that business is essential because they need to make interest payments and principal payments on the debt. They need to ensure this business will continue going forward. The more predictable the earnings, the more they will value this business because they have certainty it will continue and sustain it. And they can focus on growing it instead of just replacing it year in, year out. And then also when you go to a bank to try and get leverage to buy the business, the capital they use to buy the business is money for a bank. And a bank also is smart. They look at it and say, I don't know if this business is going to be around to make my interest payments, make my principal payments, and then repay my loan in a number of years. I'm not giving you the money to do this. Think about all the stuff that went on during COVID There are people and companies that made a boatload of money. They may have made literally like $200 million, but those businesses are worth nearly zero now. And that is when think about the predictability of the most important value drivers. How many obstacles does this business face to sustaining this performance? And can we bank on sustaining this performance? Let's get to the last, I would say fundamental component of how they structure and perform deals. Do deals. Aligning incentives is a very powerful motivator. A lot of people think private equity firms have incredibly well paid attorneys that draft up the legal documents for their deals. Having align incentives they view as much more important than having contracts. Their key criteria is like they're investors, they evaluate deals, they execute deals. They'll be pretty active from a board level and insight. I mean, it's active ownership. Like they're involved, but they're not planning on coming in and running the business on a day to day basis. They don't have the experience to do it. You don't want to see these guys, guys attempt a roofing inspection. I mean, they have plenty of skill sets, but it's not running roofing companies. They're looking to partner with investors that they trust and have confidence and faith in to lead these platforms. And they want aligned incentives that we're all shooting for the same ultimate goal of a successful outcome. In the end. Again, here's my contracts line. Because they view align incentives as way more powerful than contracts.
