What Does Private Equity Do?
With Mitt Romney entering the 2012 presidential race, his old profession of private equity has been thrown into the national spotlight. Many Americans are asking what private equity is and how one man could make nearly $200 million off it!
While investment banks buy and sell stocks, private equity firms buy and sell entire companies. They work like people who “flip” houses: they buy homes at low prices, invest some money in fixing them up, then resell them at a much higher price. Private equity firms solicit investment capital from private investors who seek higher rates of return than they expect to get from the stock market. The firm then takes these funds and purchase companies who they feel are valued too low but could easily be turned around and sold for a higher price. The private equity firm keeps the profits then invests them in new companies or shares some profits with investors.
Private Equity: A Case Study
During the 2000s, Burger King struggled to keep pace with competitors in the fast food market. It suffered from poor management, ineffective marketing, and high costs. 3G Capital, a private equity firm, saw a company with great potential but poor execution. They purchased Burger King for $4 billion. Their intent, however, was not to own Burger King forever — they wanted to improve the company and resell it for a higher price, either by finding a new buyer or taking the company public by selling shares of stock.
To turn around the company, they fired executives and brought in new talent with different strategies for growth. They hired a new marketing agency to revamp Burger King’s advertising campaigns and analyze which customers the company should focus on. They also tried to aggressively cut costs and improve profit margins, which would make the company look more attractive to potential buyers when they resold the company.
Who Does Private Equity Help?
While it might seem like Burger King was the loser in this deal, both sides won: Burger King returned to being a profitable and well-run company, and 3G Capital earned nearly $300 million for its help in turning around Burger King. It produced a win-win situation for both the new owners of Burger King and the investors who made the turnaround possible.