WHAT IS PRIVATE EQUITY IN LAYMAN'S TERMS?
Let's
say your friend is selling a beat-up old car for Rs.500.
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You
think the car's got some potential, so you go to the bank and borrow Rs.400, and you shell out Rs.100 of
your own money to buy it. You've now just entered into an investment funded
by 20% equity and 80% debt.
Now
you start fixing up the car in your garage to increase its value. You fix the
engine so that it quits making that popping noise, and you apply a nice new
shiny coat of paint to the car. All this costs you an extra Rs.100. On the side, you also
earn Rs.100/month giving
your friends rides to work every morning using the car.
You
use that Rs.100/month to start paying down your original Rs.400 loan
from the bank (+ whatever interest you've accumulated), and after 5
months, you pay it down completely. You've just deleveraged your
investment. What's more, your car is now worth Rs.1000 since
you fixed it up and it doesn't make that popping sound anymore. So you exit
your investment by selling it to a used-car dealership.
So
what's the damage? Well, you really only had to invest Rs.200 (your original Rs.100 +
Rs.100 to fix it up),
and you ended up selling it to the used-car dealership for Rs.1000. You've made 5x your money in 5 months! Not too shabby!
Private
equity is basically the same thing, though with real companies and over larger
time scales. They take cheap and under-performing companies with potential, take
them private through a leveraged
buyout (LBO), and eventually exit
at a profit by selling it to someone else.
Bibliography:
- Google.com
- Quora
- Investopedia
