Private Equity Firm’s #1 Goal = make a company worth more than it was before, in order to produce a very significant return for investors. A private equity firm’s targeted internal rate of return is between 20% and 25% 1The private equity firm then uses the money to acquire an ownership position (usually a majority or substantial minority position) in a private company.
Blackstone’s first-quarter earnings doubled from 2014 to 2015 from $813 million to $1.62 billion 2
Why does the PE firm take an ownership position? So they can take control of the company, turn it around, and sell it for a large profit at a future date.
PE firms have a reputation for being ruthless. This is driven by their motivation to run the company well because they gain a big profit from doing so. And so do their investors.
The average price-to-earnings paid for a private company in 2015 was 7.1. 3
Compare this to the public markets, where the historical average price-to-earnings ratio is between 15 and 25! 4 Relative to their earnings, private companies are bought at half to one-third the price of what would be paid for the same company if it were public, which creates a huge return potential in the case of a liquidity event.
For shareholders, it costs millions of dollars for audit requirements, financial disclosure requirements,and teams of lawyers: A study of 360 venture-backed technology IPOs found that on average 8.8% of the money raised in the IPO was paid to investment banks, accountants and attorneys! 5
In comparison, a private company can grow without being burdened with the expenses of going public, which creates substantially more earnings for a private company.