What is private equity and why is everyone always saying it's
ruining everything that you love?
Your favorite store closes, your hospital gets worse, and your
childhood brands are unrecognizable?
Chances are private equity probably bought it.
Private equity sounds intimidating, like something
only insiders understand. But it doesn't have to be.
Welcome to private equity for hot girls.
And hot girls is a mindset, obviously.
In this episode, we're going to break down private equity.
No jargon and no judgement, just cold hard insights and facts
into the most mysterious corner of capitalism and finance.
If you love business drama or you love succession, definitely
listen to this episode all the way through.
I'm Cherie. I'm Jean and.
We're the Tiger sisters. We are your Wall Street and
Silicon Valley Big Sisters. And we're a top ten business
podcast on Spotify where we talk about money, power, and love.
In this episode, we're going to break private equity down into 5
juicy parts. The 1st is what PE actually is.
The second is how PE firms make their money, which is millions
and billions. The third is what is a leveraged
buyout, also known as an LBO. The 4th is why does PE always
get dragged in the media? And the 5th is what it means for
you as a founder, customer or an employee of APE purchased firm.
By the end, you'll understand why PE is always the villain in
the media, and whether or not that's actually fair.
Please remember to like, follow, and subscribe.
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Let's get into it this episode of.
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And we're back. OK, so this is Part 1.
What even is private equity? Let's get into the definition.
There are three things that define private equity.
The 1st is private ownership. For the most part, private
equity firms invest in companies that aren't on the public
market. They are private companies.
Second is control. When private equity companies
invest or buy companies, they usually buy a majority stake of
the company. The 3rd is a turn around
mindset. The goal is to buy the company,
increase the value value and sell it for a profit.
Yeah. So think of it like this.
Instead of buying a few shares of a company on Robin Hood or on
the stock market, PE companies actually come in and they buy
either the whole company or majority stake, and then they go
ahead and make improvements, they increase efficiencies, and
then they turn it around and sell it for a profit.
So PE is different from VC venture capital because venture
capital usually goes for the big bets, the earlier companies that
are much riskier, whereas private equity companies
generally target much larger companies that are bloated or
have inefficiencies or real ways you can turn it around and then
sell it for profit. Basically, these are larger
companies that are more developed but are fixer uppers.
Right. So it's kind of like flipping a
house. You come in, you see the
potential, you renovate it, you flip it, you sell it.
For more, think of brands like Burger King, Neiman Marcus,
Dollar General, Dunkin' Donuts, Dell Computers.
So many different brands that you interact with on a weekly
basis have been a part of private equity.
OK, Sheree, so let's move on to Part 2.
How do PE firms actually make money?
So there are two main ways PE firms make money.
The first one is management fees where they get typically 2% just
to manage the PE fund. So let's say PE fund raises a
billion dollars, that means they're getting $20 million a
year just to manage the fund. The second one is the more
important one that's carried interest and it's typically 20%
on all the successful deals and that's where the magic happens.
So this sounds kind of complicated, but it's actually
very common and you'll hear people talk about it in 2 and
20. They'll just say that phrase 2
and 20 talking about the management fees and also the
carried interest. So Jean, where do these private
equity firms actually get their money from?
Yeah, good question. So in this example before where
I said, you know, this PE fund raised a billion dollars for
their fund, they typically get that money from three different
sources. The first one is LP's or limited
partners, which is basically investors in the fund.
These are typically big institutions like endowments,
high net worth individuals, other sorts of investment funds.
And pensions. And pensions.
Exactly. The second source is the PE fund
itself. They always put in a little bit
of money themselves just to have skin in the game.
Yeah. And a lot of limited partners
like to see this because if you're the management team and
you're charging those management fees, you also want to have some
of your money invested into the firms as well.
And the third one is debt, which brings us to the next section,
which is leveraged buyouts. When I first learned about
private equity, I was most surprised to learn about the
debt portion. It's actually a lot of borrowing
that's going on to then invest. So this is where LBO's leveraged
buyouts come into play. So what exactly is a leveraged
buyout or an LBO? This is where private equity
firms take on debt. They borrow money to then buy a
company. And once the company starts
doing well, you know, the private equity firm starts to
turn it around. It's making profit.
They use that profit to then pay off the debt of the purchase of
the original purchase. So that's where the leveraged
buyout comes in. Going back to the house flipping
example that Gene gave before, if you think about a house, once
you fix up the house and you rent the house out to people,
you take in tenants and then you use the monthly rent to pay off
the mortgage. So that's a similar example of
how an LBO type model would work with everyday housing.
Yeah. Or if you want to put some
numbers to it, you know, if you buy this house for $100,000,
it's $1,000,000 house, you actually put in $100,000 of your
own and you take on $900,000 of debt and then you actually
improve the house and you make $100,000.
You're actually already making a the return like of 2X on what
you actually put in. So that's why Lobos are so
powerful. The keyword is leveraged, right?
The idea that you're taking on a lot of debt so that you can do a
lot more with a lot less of your own money.
But it's not always rainbows and butterflies and sometimes an LBO
goes wrong. So she do you want to share an
example? An example of that is Toys R Us.
They took a $6.6 billion LBO out in 2005, and that was $5.2
billion of debt. And what ended up happening, as
the lure goes, is that Toys-R-Us actually wasn't able to be
turned around. It wasn't a successful company
and so they ended up having to pay like millions of dollars in
just interest. Yeah, so they actually had to
spend all their money servicing their debt.
So they didn't really have as much money leftover to make the
improvements that they needed to fight with, say, like Amazon,
which was coming up at the time. And a lot of people were buying
toys from Amazon. So RIP.
I actually remember that we used to go to Toys-R-Us all the time
when we were kids. Yeah, it was like the place to
go member. You always just be like, please
let let's go to toys. R Us.
It was amazing. It was a Mecca, honestly.
It was so gorgeous in there, all the lights and the colors.
Yeah. So let that be.
A lesson. A lesson.
Yeah. And by 2017, they were actually
bankrupt. And that's the risk of taking on
debt or leverage. It could work out really well
and you could make millions and millions of dollars, or it could
really burn down the. House.
Yikes. Dramatic.
Mm Hmm. OK, so next is part 4.
Why is private equity always the bad guy?
And we'll get to it right after this break.
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of Tiger Sisters. Now back to the show.
And we're back. OK, so Sheree, tell us, why is
private equity always the bad guy?
I think in media private equity, it gets a really bad reputation.
There's a lot of movies and films and TV show that just
shows like the slimmier parts of private equity.
I think that's number one, How it's portrayed in media, but
also how customers, consumers and employees are treated does
not help with the reputation of private equity.
The first reason why it gets a bad reputation is because of
layoffs. Often times when private equity
firms are turning around companies, they have to do mass
layoffs as a way to boost efficiency or improve the
company and that that impacts day-to-day people and the
employees. I guess they don't have to do
it, but that's typically a very strong lever for them to cut
costs and therefore increase. Profits, yeah.
The second thing is prioritizing short term benefits over long
term health. A lot of private equity firms
have to be careful not to do this, or else they risk
improving the profits kind of artificially.
Yeah. And this is, it actually depends
on the PE fund and also kind of what size they are and what
their plan is for the company that they purchase.
Because a lot of times I guess maybe this is like another
dirty, dirty secret of PE is that there goal is to actually
improve the efficiency of the company and then sell it to
another PE fund. Like they just kind of want to
hit a certain level of like profit and then move on to the
next one. Right, because there's different
sizes of PE funds and different types of companies that they
buy. And so actually something that I
learned when I was taking a private equity class at Stanford
last year is that most of the exits, the exits of these PE
firms is selling to another PE firm that takes on the company
when it has grown to a certain size, which is how they make
money. The third reason why private
equity gets a bad reputation is because of the asset stripping.
Like one lever they can pull in order to cut down cost is to
sell things that the company owns.
For example, if the company is a manufacturing company and they
have really big machines or expensive machines, one thing
that they can do is strip the assets and sell it.
But that might not be good for the long term health of the
company, although it does raise profit.
And the fourth reason why private equity gets a really bad
reputation is because of industry sensitivity.
A lot of healthcare firms or hospitals are actually
controlled by PE firms. And when incentives may not be
necessarily aligned or there's different stakeholders in the
entire equation, PE firms, definitely their goal is to
return money to the shareholder. And when that collides with
hospitals or healthcare funds or education, it can get really
sticky. Yeah.
And I think especially when it comes to industries like
hospitals, it's always just a really bad headline.
If it says like, you know, there's the like we've talked
about headline risk before on Tiger Sisters.
There's just a lot of headline risk when it comes to these
industries because you don't really want to be pointed to as
like the evil company that laid off 30% of hospital.
Workers, right, Right. Because there's a lot of
downstream effects too that can ladder up to that.
And then the PE firm will inevitably be blamed for that.
Right. And it's not always just
sensitive industries like hospitals either.
It's across all different industries.
Like for example, think about Vice Media, which used to be a
global media company. I remember they raised $1.6
billion, including from PE funds like TPG and they weren't able
to make it work and they ended up declaring bankruptcy in 2023
and laying off hundreds of employees.
And going back to the Toys-R-Us example, over 30,000 people lost
their jobs when Toys-R-Us went under.
Yeah, and there's so many examples in retail.
So thinking about j.crew, thinking about Payless, both of
them went bankrupt at some point and ended up shutting hundreds
of stores. But to be fair, not all PE is
bad. So look at what Blackstone did
with Hilton for example. They bought it, they improved
it, they expanded it globally, and they actually took it public
again. Yeah, they ended up making 14
billion on that deal and they didn't have to do mass layoffs.
Many times it comes down to incentives and style of the PE
firm. It depends on the firm itself,
how big it is, what industry it's in and the strategy that
they employ to turn around the companies.
A lot of firms are able to do it, and then sometimes they're
not able to. OK, Sheree, on to our last part,
Part 5, which is how PE effects you as an employee or customer.
So what can you expect if your company gets acquired by a PE
firm? Yeah.
I would say there are three main things.
The first one is efficiency moves, AKA typically cost
cutting. And tighter budgets.
The second one is new leadership.
A lot of time these PE firms actually bring in people from
outside the company. A lot of times they're actually
operators that exist in the PE firm to come lead the new
company. Yeah, because PE firms, if
they're turning around a company, they want to bring in
people that they trust and know can do the job.
And that they know will execute their strategy.
True. And then the third one is
restructuring AKA layoffs, which is to boost profitability.
And as a customer, if a PE firm has acquired one of your
favorite brands, you might see higher prices were service and
leaner offerings. Yeah, this reminds me of when my
girlfriends and I heard that Zimmerman, you know, the
Australian like dress brand for women, designer brand when they
announced that they were PE acquired.
We were like, oh shit, like better buy up all that Zimmerman
now because next season it's probably going to be worse
quality and it's going to be more expensive because the PE
fund is going to try to like squeeze their profit margins and
improve them. So that was just like a small
way where like we were like, uh oh.
We know what's coming. Yeah, like time to buy up the
kind of like vintage Zimmerman. But as devil's advocate,
sometimes you do get better service.
PE firms are known to cut the bloat and make things more
efficient, so that also trickles down to customer experience as
well. Yeah.
I would say a lot of times PE firms like what they say they're
good at is improving operations. So if that's a big part of the
business, that can be something that as a customer you might
experience improved operations. OK, and we'll wrap up this
episode with our main takeaways. After this break, we'll talk
about is PE evil or just misunderstood?
OK, and we're back, so let's wrap up the episode.
So Sheree is PE evil or just misunderstood?
My take personally is that private equity as a funding and
like finance mechanism isn't inherently evil.
Yeah, I would agree with that. I just think that if it's
something that's touching, like your salad chain, your hospital,
your favorite clothing brand, it's important to understand it
so you can know how it affects your everyday life.
And part of understanding it is actually knowing what private
equity is, which now you guys do after this episode, and then
understanding what are their goals, what are they optimizing
for so that you can figure out how it affects you.
Because when you follow the money, you end up seeing the
incentives of the firms and what they're trying to go for.
Yeah, the hot people understand incentives.
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