The Strategies of Private Equity Business Buying

In short, Private Equity firms buy or buy into businesses and either make money off of the profit while doing business or sell them at a profit. In recent years, private equity companies have amassed massive amounts of money while pursuing ever-larger purchase targets and profits.

The way that these private equity firms have expanded and generated high rates of return hasn’t gotten much attention though, partly because it sounds simple enough: purchasing businesses and then selling them after guiding them through a period of fast performance improvement. But it’s how they do that which makes them so successful.

Here we explore some of the strategies that private equity firms use to buy, grow and profit from their business deals & transactions.

Specialized Private Equity Buyer Strategies

There are a number of ways that private equity firms purchase businesses and buy businesses in different states of existence. Every business and every transaction can have a unique need and strategy used to find and purchase the business.

Here are some of the specialized private equity buyers:

• Recapitalization – These corporations are seeking companies in which they may invest and assist fund expansion as well as the acquisition of a portion of the ownership. This is typical in organizations with a strong track record of success or that have a major potential ahead of them that would necessitate a cash injection that the current owners are unwilling or unable to deliver. In exchange for their investment, these funds often obtain a minority stake in the firm.
• Search Method – The search fund method has grown in popularity in recent years. These firms hire prospective CEO candidates to assist them in locating, purchasing, and operating portfolio companies. These applicants are encouraged throughout the search process and are granted a stake in the portfolio company in exchange for their involvement and effective operation. This technique gives a significantly bigger pool of prospective acquisition targets in cases when the owner or key decision makers are departing following the sale.
• Turnaround Strategy – A turnaround  strategy requires investing in companies that can be purchased and improved on to restore them to profitability and earn the desired returns. These companies will typically get acquired at a very low price, well below market value. The current owners are paid a portion up front, and their remaining payments are contingent on the success of the turnaround.
• Distressed Assets – There are entities that invest in businesses that are not performing well but have valuable assets or potential for optimization to increase profits and growth.

Private Equity Realization Strategies

How do Private Equity Firms make money from their investment? When private equity buyers invest their money, they do it in accordance with a predetermined investment plan that is presented to investors when the funds are raised. This investment approach has the potential, and most likely will have an impact on how they run a business following the sale.

Here are examples of the investment criteria used:

• Long term hold – Most private equity buyers are looking for solid revenue-producing companies to purchase and use the money generated to provide long-term profits. Firms using this strategy are often planning to hold for ten years or more and will spend money to assure the company's future performance. They can keep business operating indefinitely if it continues to meet the group's performance goals.
• Ownership position – The level of ownership purchased by the private equity buyer will be determined after the investment is raised. Some companies need majority ownership, while others would accept a minority investment. But the position needs to be significant enough for the investment to make sense for both the firm and its investors.
• Desired minimum return – Each fund will seek a specific rate of return. This return might come from either yearly income or value increase. It is frequently a mix of the two. In a later essay, we will go through this in further depth.
• Predetermined hold – This is the most frequent private equity buying strategy. They want to buy and hold for 3 to 10 years, depending on their investing objectives. This will necessitate a very specific value creation timetable. These firms frequently consider add-on acquisitions and investments that will result in a higher short-term increase in value and profitability. The average hold duration is roughly 5 years.

Private equity firms are in almost every case the best decision makers when it comes to buying businesses and generating a profit from them after the purchase. There will be adjustments after the sale, just as there will be for any buyer, but for the seller, the private equity purchasers will likely have to manage the money properly and repay seller financing in order to expand their carried interest in the future. They are tremendously motivated to increase the worth of the company.

We hope this was helpful in understanding better why and how private equity firms invest in different types of businesses.