Private Equity Firms: What are they?

The investment market isn’t immune to trends. While most trends come in the form of specific stocks, values, or markets to invest in (for example, cryptocurrencies,) there are always outlier trends, trends that aren’t so much expectations about the market but tricks and methods to optimize investment.

Sometimes, these trends are sold as ways to make people rich quickly with a minimal amount of work.

Private equity firms are one of the trends we see currently. The concept itself has been in the news often, usually blaming them for people getting laid off or praising them for creating new jobs, with most people unable to understand just what equity firms do.

How do these firms work?

A private equity firm is, to put it simply, a conglomerate of investors who get together to purchase companies or businesses in a private manner – that is, outside the stock markets. The earnings these businesses receive (i.e., the equity) is then divided among those investors who chipped in to take over the company.

Although simplistic, that’s basically how it works: A bunch of people with money get together, pool their money into a private equity firm, and share both the risks and the proceeds of such venture.

Usually, this is done through already existing private equity firms, although it’s not uncommon for individuals to start their own.

Are they good or bad?

As with everything in business, this will depend on who you ask – and the specific private equity firm you look into. In theory, a private equity firm taking over shouldn’t be any different than having a new board of investors for publicly traded companies. After all, that’s literally what such takeovers mean.

However, the experience many workers have had with these firms is quite different. While it’s no secret that public investors often try to get the most money they can out of businesses, there are two sides to the stock market that keep these attitudes relatively in check.

First, who owns how much of each company is known. And second, the most valuable companies in the stock market (say, Amazon or Apple) are mainstays and it’s in the investors’ best interests to sacrifice short-term gain for long-term stability.

This is not necessarily true of private equity firms. The relative anonymity these firms give allows certain savagely capitalistic players to act in ways that, were they to be made public, would likely damage their images – and those of their companies.

Private equity firms effectively lessen this, because it’s often impossible to know who is behind the company.

There’s a second issue, although closely related. Private equity firms are known for often acting in extreme ways once they take over, sacrificing long-term stability for short-term earnings, often forcing companies to cannibalize themselves and their own market.

 This leads these companies that have been taken over to end up bankrupt, its employees laid off, all to fill the pockets of people who already had much more money than the company’s workers.

Is there an upside?

One might argue that the operating strategy that these firms use could lead to better economic development, as many of the pressures of public trading, such as stock price variations, don’t exist.

And that is true. A properly managed private equity firm can indeed help a company, or a whole industry, flourish under the guidance of leading experts.

However, this doesn’t always happen – partly because some of the biggest actors in the market are only in it for the money, with little interest in making things better.

Conclusion

The fact that some firms are there to drive companies to the ground doesn’t mean they all will. Some private equity firms will indeed act in ways that will better the market, and we can hope with time the good companies will outweigh the bad.