Published May 20, 2011

What is Private Equity?

By Paul Wormley

We frequently meet with small business owners who aren't familiar with private equity – how it works or why a private equity firm would be interested in buying their business.

A number of years back I had to explain my chosen occupation to my grandfather & a dairy farmer and, by extension, a small business owner. He was savvy guy, like most small business owners, but ‘private equity' wasn't exactly a household term on the farm. Here's how I described it:

My partners and I are investment managers – kind of like mutual fund managers that invest in public companies on behalf of retail investors. But instead of managing a mutual fund, we manage a fund that acquires small, private companies using equity capital from sophisticated investors (hence the term "private equity").

There are different kinds of private equity just like there are different kinds of farming (dairy, hog, grain, etc.). Examples include:

&         Venture capital: investing equity in start-ups and emerging companies

&         Distressed/turnaround investing: buying and fixing troubled companies

&         Leveraged buyouts: acquiring established businesses using debt and equity

And, just like different types of farming, there are specialized skills required to be successful in each type of private equity.

Private equity funds are structured as limited partnerships wherein each investor owns a small percentage of each company acquired by the fund. Limited partnerships are similar to farm co-ops where everyone pools their capital to pursue a business opportunity. Instead of building and operating grain elevators, Hadley Capital buys and grows small businesses.

When Hadley Capital makes an investment, the acquired business is owned by our fund as a stand-alone company. Just like a mutual fund manager makes multiple investments inside a mutual fund, Hadley Capital has a portfolio of investments in multiple small companies (hence the term "portfolio companies").

Like all investment managers, Hadley Capital's goal is to increase the value of our investments. Our strategy is to grow and improve our portfolio companies over a 5 – 10 year period, thus increasing the value of our investment.

There is one other similarity between private equity and farming that my grandfather would appreciate but that I didn't get to share – we both invest our hard-earned capital for a hopeful, but uncertain, return.