Private equity means investing in
- Private companies
- Public companies that will be bought off the stock market to become private, e.g., Dell
Private equity can be classified in
- Buyout: invest in large, mature companies using a significant amount of debt
- Venture Capital: invest in small, young companies using little or no debt
A buyout example – how leverage can increase return
Buying a company with $5M EBITDA for $40M
Without leverage
- Equity purchase price: $40M
- Annual return: $5M/$40M = 12.5%
With leverage
Borrow loan: 4x EBITDA = $20M, 5% interest rate = annual interest payment of $1M
- Equity purchase price: $40M – $20M debt = $20M
- Annual return: $5M – $1M interest = $4M, $4M/$20M = 20%!