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Private equity: Everything you always wanted to know about this $12 trillion asset class but were afraid to ask

By Steve Gelsi

Private equity is part of the lives of most Americans -- whether they know it or not

Whether you're a stock-market investor, an employee of a private business or a customer of one of the thousands of consumer-facing companies owned by private-equity funds, private equity is part of your life.

It's a world that remains out of the spotlight much of the time, but one that has grown too big to ignore.

Assets under management have tripled to $12 trillion in less than a decade, making the world of alternative investments a significant part of the overall economy.

By comparison, the U.S. stock-market pantheon of 2,800 New York Stock Exchange stocks and 3,300 Nasdaq stocks tips the scales at a combined market capitalization of $46.2 trillion.

Outside of those roughly 6,000 listed companies on the Nasdaq and the NYSE, the world of private equity is a major player in the larger universe of private companies, often owned by families or other private-equity firms.

Private-equity firms are currently invested in about 14,300 companies in the U.S., according to industry estimates.

About 21,000 businesses in the U.S. have 500 or more employees, according to the Small Business & Entrepreneurship Council. Along with those larger companies, the U.S. currently supports more than 33 million small businesses employing 61.7 million people, according to the Small Business Administration.

That's a very big sandbox outside of the smaller world of publicly traded companies.To put the $12 trillion under management in alternative investments into further perspective:

U.S. banks reported total combined assets under management of $23.47 trillion as of June 30.The U.S. Social Security Administration reported $2.83 trillion in trust-fund reserves in its 2023 report.Total U.S. retirement assets for the U.S. were $36.7 trillion, including $13 trillion in individual retirement accounts and $10.2 trillion in defined-contribution plans such as 401(k)s, as of June 30, according to the Investment Company Institute.

Private-equity firms are often involved in the birth of publicly traded companies by backing initial public offerings. They also lead take-private deals that end the life of public companies on the NYSE or Nasdaq when they buy all the common stock in a target business.

If you're one of the roughly 19 million public employees in the U.S. working for a state or municipality, or if you work for a large learning institution, a chunk of your retirement plan's money is invested in private-equity funds, private credit funds and other alternatives.

Nuts and bolts

So what exactly is a private-equity fund and how does it work?

Not unlike an exchange-traded fund or a mutual fund, a private-equity fund holds a basket of companies. Traditional private-equity buyout funds are typically made up of 10 to 15 companies, versus the dozens or hundreds of companies in an ETF, say, for the S&P 500 SPX or the Nasdaq-100.

Private-equity funds are also similar to stocks, because both stock owners and private-equity fund owners purchase equity in companies. Private credit funds resemble bonds in some ways, because both represent investments in debt.

Unlike money invested in stocks or bonds, however, money put into a fund is typically locked up for at least 10 years, although investors -- also known as limited partners, or LPs for short -- start getting some of their money back within a few years as the firm sells, or exits, its portfolio companies.

Early in the life of a fund, private-equity firms call in capital from their investors to buy companies. The firms typically own the companies for three to five years and then sell them.

Every time a sale happens, the LPs are entitled to 80% of any profit from the sale of the company. The private-equity fund's general partners, or GPs -- made up of private-equity executives -- get 20% of the profit, which is called carried interest. By the end of the life of a fund, all the companies have been bought and sold, with cash dispersed to investors and the firm.

Once a firm deploys about 70% of the capital in a fund, about four to six years into the life of the fund, it starts raising capital for its next fund.

Another subset of the alternative investments has grown up around the sale of stakes in private-equity funds. If an investor wants to get out of a fund for whatever reason, that investor is often able to sell its stake to another investor on the secondary market. This has grown into a huge business in its own right, with massive secondary funds made up of many stakes in private-equity funds. In another twist, some investment shops buy up stakes in private-equity firms.

While private equity has been on Wall Street's map as a separate practice since the 1980s, the industry was formerly known as merchant banking. Banks would invest off their own balance sheets to buy companies or other assets and would often line up investors either from within the bank or elsewhere to provide capital.

After the global financial crisis of 2007-08, many banks spun off their private-equity units into independent firms.

However, Goldman Sachs Group Inc. (GS) has continued to run its merchant bank, which it folded into its Global Asset and Wealth Management unit.

Also read: Goldman Sachs's private-equity business has been a 'black box,' but now it's opening up

Image problem

To be sure, the private-equity business is not always portrayed in a favorable light. Books such as the 1989 bestseller "Barbarians at the Gate" by Bryan Burrough and John Helyar, or the recently released "These Are the Plunderers" by New York Times writer Gretchen Morgenson and financial-policy analyst Joshua Rosner, portray a world of wheeling and dealing by greedy executives who are enriching themselves with little regard for the workers at the companies they target. The titles of the books alone say as much.

Private-equity firms may make a lot of money, but they do a lot better when their portfolio companies thrive from their investments, and not from looting them.

Some private-equity executives have complained that the industry has an image problem -- one that venture capitalists have mostly managed to avoid by positioning themselves as thought leaders and trend setters by investing in hot startups.

Others point out that the industry shows merit because it's had a solid track record of stewardship for major pension funds and other institutional investors.

"I disagree that private equity has a general, across-the-board image problem," said Kelly DePonte, managing director of Probitas Partners, a placement firm that helps alternative-investment managers raise capital. "There are certainly bad actors in the industry -- as there are in all industries -- and certain academics and politicians are negatively focused on fees. But many investors look at returns net of fees as attractive, especially compared to other investments over the past decade."

But there's no question that the riches made in the industry may cause some to wonder whether the industry plays a fair game.

Among the wealthiest executives in the U.S., Stephen Schwarzman, chief executive of the largest publicly traded private-equity firm, Blackstone Inc. (BX), earned about $1 billion in dividends from his company's stock plus about $251 million in compensation in 2022 alone. Forbes magazine estimates his current net worth at about $35 billion.

By contrast, BlackRock Inc. (BLK) Chief Executive Larry Fink, who runs the largest asset manager in the world, with assets under management of $9.4 trillion, is worth about $1 billion, according to Forbes.

Private equity has mostly kept a low profile, with few household names in the business.

When Mitt Romney, co-founder of large private-equity firm Bain Capital, ran for president against Barack Obama in 2008, he famously said, "I like being able to fire people." Romney made the remark in the context of his healthcare platform, as he explained how it's a good thing for people to be able to switch service providers if those providers are not meeting their needs, but the comment was often cited as an interpretation of his job as a private-equity executive.

One of the only highly visible people in the world of private equity right now is reality TV star Kim Kardashian. She is currently at the helm of Skky Partners, a firm she co-founded with Carlyle Group Inc. (CG) veteran Jay Sammons that's taking aim at investments in fashion, media, beauty, media, hospitality and food.

Politicians including Democratic Sen. Elizabeth Warren have criticized private-equity firms as loading up their portfolio companies with debt and then laying off workers. In 2021, Warren filed a bill called the Stop Wall Street Looting Act, but the legislation has never made it out of Congress.

Instead, private-equity firms last year managed to keep carried interest taxed at the same level as capital gains rather than as income, a move that saved the industry tens of billions of dollars in potential tax increases.

Also read: We expect it to be removed': Democrats' push to close 'carried interest loophole' in jeopardy as Sinema seeks to block effort

Stewards of capital for retirement funds

While private equity has a reputation for excessive profits and "looting" on one side, pension funds and other managers of retirement capital have been pouring more and more money into the asset class.

The money raised by private-equity funds peaked at more than $1.1 trillion in 2021. While it has been affected by rocky financial markets in 2022 and 2023, the industry still has more money than it has been able to deploy.

Private-equity firms often face an issue that few would consider a problem: too much money waiting to be put to work. This cache of so-called dry powder rose to nearly $2 trillion in 2022.

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10-28-23 0947ET

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