A primer on private equity Based on the article by Felix Barber and Michael Goold Harvard Business Review, September 2007

How private equity works Funds are raised from institutions and wealthy individuals. After specified amount is raised, fund is closed to new investors. Money is invested in buying businesses. All businesses are sold and fund liquidated in a predefined time frame, typically less than 10 years. PE firms are typically structured as private partnerships.

Role of investors Fund management contract may impose limits on the size of any single business investment. Once money is committed, investors have no control over management. Investor advisory council has few powers, compared to the board of a public company.

Minimising the agency problem Private equity firms exercise control over portfolio companies through representation on the company board. CEOs may be asked to invest personally. This ensures alignment of incentives. Operating managers receive attractive incentives linked to profits when the business is sold.

Fees and incentives Funds typically charge A fee of about 1.5-2.0 % of assets under management 20% of fund profits subject to a minimum rate of return for investors Fund profits mostly realised through capital gains

Where private equity makes sense PE firms typically show interest in companies where High debt makes sense There are stable cash flows There are limited capital investment requirements There is at least moderate future growth There is opportunity to enhance performance in the short- medium term