WTF is PE? Decoding Private Equity and How Investors Make Money
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What do LeBron James, Kim Kardashian, and Will Smith all have in common? Well, they're investors in private equity. Private equity is not just for celebrities, though. P.E. has been a staple on Wall Street for decades, and some of the biggest financial institutions like Blackstone, BlackRock, and Goldman Sachs have also been involved with private equity. But to invest in P.E., do you need to be a gazillionaire or a celebrity or both?

Today, I'm going to be talking about what PE is and who it's for. But let's start with the basics. At its core, private equity refers to investments made directly into private companies or the buyout of public companies that result in the delisting of public equity. And we've actually heard an example of this. You might remember my interview with Neil Parekh, one of the Casper co-founders, who talked about when their company went from a private company to a public company and then

back to being a private company after being acquired by PE firm Durational Capital Management. At the most basic level, private equity firms invest in businesses that are not listed on any public stock exchange. They often buy entire companies, make them more profitable, and then later sell them for more than they bought them for.

Private equity firms raise funds from investors called limited partners or LPs. And for private equity, investors aren't always wealthy folks. Sometimes investors are pension funds or insurance companies or endowments. These PE funds then use that money to buy stakes in private companies or public companies that they plan to take private. So what is the draw for investors?

Well, private equity investments are typically long term and can offer big returns, often higher than those from public stock markets. However, these investments also come with higher risks and are usually less liquid, meaning it's harder to sell them quickly. You can't just open your brokerage app and sell your shares like you would a public company.

And your money is often locked up for a long term, typically seven to ten years. So we just talked about the investors, but what's in it for the firm itself? Typically, private equity firms charge a management fee and a performance fee. The management fee is usually around two percent of the committed capital, which goes toward the operational costs of managing the actual fund. The performance fee, often called carried interest or just carry, is around 20 percent of the profits generated from those investments.

So this fee structure really incentivizes the private equity firm to maximize returns for their investors, because if their investors do well, they do well. You might be asking yourself, how is this different from venture capital? Great question. Venture capital is actually a subset of private equity. VC firms typically invest in startups or early stage companies that have high growth potential but are also high risk. Think of companies like Uber or Airbnb before they became household names.

Private equity firms make money in a few different ways. One of the most common methods is through leveraged buyouts, also known as LBOs. In an LBO, the private equity firm buys a company using a significant amount of borrowed money. The idea here is to use the company's own assets and future cash flows to pay off that debt.

This can mean more returns later on, but also seriously increases the risk if the company doesn't do well. Another strategy private equity firms use to make money is called growth capital. This involves investing in companies that are looking to expand but need money to do so. These are typically companies that are already established, profitable, but just need more funding for new projects, acquisitions or to enter new markets. So how do private equity firms add value to companies they're investing in?

It's not just about providing money. Private equity companies also take an active role in the management of their portfolio companies. They might bring in new leadership, streamline operations, or help expand into new markets. The goal here is to improve a company's performance and profitability, making it more attractive for a future sale or a public offering.

So let me give you an example of what this might look like. Imagine a private equity firm buys a retail company. They might replace the management team, revamp the company's online presence and renegotiate supplier contracts to cut costs. After a few years of improvement, they sell the company at a much higher price than they paid for it, generating a hefty return for their investors. This is the happily ever after scenario that PE firms shoot for.

Now, who can invest in private equity? Unfortunately, or maybe fortunately, private equity investments aren't open to everyone. PE is typically reserved for accredited investors. These are people or institutions that meet certain financial criteria, ensuring that they can handle the risks involved. This means that for most everyday investors, direct access to private equity firms might be out of reach.

So then why should you care about private equity firms as a new investor, you might ask? Well, understanding private equity can give you a broader perspective on financial markets and investment opportunities. Even if you can't invest in private equity directly, knowing how it works can help you make more informed decisions about your investments. For example, if you're investing in public companies, it might be useful to know which ones are targets for private equity buyouts or which companies have private equity backing. These factors can influence stock performance and give you insights into market trends.

For today's tip, you can take straight to the bank. If you are really feeling PE, there are ways to get exposure without being an accredited investor. There are some platforms that allow smaller investors to pool their money together and invest in private companies, though they often come with higher minimum investment requirements and fees. And some mutual funds and ETFs also invest in private equity or companies that are heavily involved in PE deals. Between summer vacations and going to the beach and having the hot girl or guy summer of your dreams,

season can be a little hard on our wallets. A Chime checking account helps you reach your financial goals while still enjoying the summer. You can take back your finances with features like fee-free overdraft up to $200 with SpotMe or getting paid up to two days early with direct deposit. Learn more at Chime.com slash MNN. And you know I hate overdrafted fees. One time I overdrafted buying a latte, which was so embarrassing at the time, but hey, it happened.

That's Chime.com slash MNN. Chime.

Feels like progress.

When you're in the market for a new SUV, you want a vehicle that can handle your daily commute, navigate the elements, and adventure with ease, right? You need the reliability of a Toyota and the confidence that your investment will last. Why? Because after all the carpools, rugged trails, and weekends out, you want an SUV that still has plenty of miles left in it and holds its value for a great trade-in deal. That's where Toyota leads the pack.

as the number one resale value brand for 2024, according to Kelley Blue Book's KBB.com. So check out the legendary redesigned Land Cruiser or spacious Grand Highlander or test drive a RAV4 available in gas, hybrid and plug-in hybrid models. And remember, when you choose a Toyota, you're not just buying a vehicle for today, you're investing in trade-in value for tomorrow.

Visit buyatoyota.com, the official website for deals, for more. Vehicle's projected resale value is specific to the 2024 model year. For more information, visit kellybluebookskbb.com. Kelly Blue Book is a registered trademark of Kelly Blue Book Co. Inc. Toyota, let's go places. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Levoy. Our researcher is Emily Holmes. Do

Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at moneynews and TikTok at moneynewsnetwork for exclusive video content. And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.

Money rehabbers, you have money hidden in your house. Yeah, just hiding there in plain sight. Okay, so I don't mean you have gold bars hidden somewhere in walls, treasure map style, but you do have a money-making opportunity that you're just leaving on the table if you're not hosting on Airbnb. It's one of my all-time favorite side hustles. By hosting your space, you are monetizing what you already own. It doesn't get easier than that. For me, hosting on Airbnb has always been a no-brainer. When I first signed up, I remember thinking to myself, sell

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When you're in the market for a new SUV, you want a vehicle that can handle your daily commute, navigate the elements, and adventure with ease, right? You need the reliability of a Toyota and the confidence that your investment will last. Why? Because after all the carpools, rugged trails, and weekends out, you want an SUV that still has plenty of miles left in it

and holds its value for a great trade-in deal. That's where Toyota leads the pack as the number one resale value brand for 2024, according to KelleyBlueBooksKBB.com. So check out the legendary redesigned Land Cruiser or spacious Grand Highlander or test drive a RAV4 available in gas, hybrid, and plug-in hybrid models.

And remember, when you choose a Toyota, you're not just buying a vehicle for today. You're investing in trade-in value for tomorrow. Visit buyatoyota.com, the official website for deals, for more. Vehicles projected resale value is specific to the 2024 model year. For more information, visit kellybluebookskbb.com. Kelly Blue Book is a registered trademark of Kelly Blue Book Co. Inc. Toyota. Let's go places.