Transcription
Hi, it's Patty Hers Marketplace. So, what is a private equity fund? Well, it's a collection of investors who get together to buy a company and actually to flip a company using a process called a leverage buyout.
So, a private equity or PE as they like to be called, a PE fund. All right, here we are. So a PE fund is actually the same as an LBO fund. And in fact, they used to be called LBO funds back in the 80s, but then they kind of fell out of favor and so they changed their name.
Anyway, so this actually works using a process. This le this leverage buyout thing use works using a process that's very similar to kind of flip this house. All right, so say we have um we've got a house, right? It's a it's worth $10 million. It's a big house in the country. Okay, it's actually got um it's got like servants quarters and all the rest of it. It's actually got a bunch of staff in there, butler, you know, cook, all the rest of it. And a bunch of investors see this place, this $10 million home. They think, "Yeah, we could we could buy this and flip it." Right?
So, the investors all get together. Okay? They all there's like 10 of them. They all get together, these guys, and they uh they club together and they get a million dollars. Okay? But obviously that's not enough because of they $10 million. So, what do they do? They go to the bank. All right? And they say to the bank, "Look, bank, can we can we borrow $9 million?" And the banker says, "Okay, yeah, here's 9. Here's 9 million for you because I can see that you're putting some money up yourself. I'll lend you the money. Want it back in 5 years? Off you go."
So, we've got 1 million plus 9 million equals 10 million. That's great. They go and buy the place out. Next thing they do is they say, "Well, in order to make this happen, we're going to have to sell sell some assets." So, they sell a bunch of the land off. Okay? They sell half the land off. And then they knock down all of the uh the staff quarters here. All the staff quarters go and then they they sack all the staff except for the butler. And then they renovate. They put in hardwood floors and granite countertops and all the rest of it. And five years later, they flip it and they sell it for $20 million. Yay.
Of course, this is great because all they had then have to do is to pay the bank back and then they can divide the spoils amongst themselves. So like $11 million, probably like $10 million after they paid all the interest, they can divide amongst themselves. So that's how Flip This House works. That's exactly how private equity works.
See these private equity guys, these investors are things like venture capital companies, hedge funds. They're also pension funds. So, they might even hold some of your uh your pension or your 401k. They pony up the million dollars, which is the the private equity. That's the equity stake that they hold. They then get the leverage, okay? They go to the bank and they say, "Let's lever up. Let's borrow a bunch of money in order to buy a company that we like the look of." They get a bunch of leverage. Here's the leverage. And then they do the buyout where they find they look for a company that they think is maybe underperforming or they can they can they can strip it down and make it better.
So, they buy out a company. All right? They then strip that company down, maybe sack a bunch of staff, maybe sell off a bunch of assets, streamline it, and then five years later, they turn it around and they sell it for more money and then pay back the bank and pocket the money themselves. That's how leverage buy works. That's what private equity funds do. That's the kind of core of their business.
And as I say, you can be invested in this in indirectly because you might be uh your pension fund might be one of these private equity investors, might be invested in the fund itself. You might also be involved in the lending side because the bank, okay, doesn't hold on to this loan. It actually it can actually sell it off to a bunch of other investors, which can include perhaps your pension fund or your uh or the the the company that holds your retirement account. So, you can be invested at two stages of this process, even indirectly.
Now, private equity funds do work. They do a lot of good business. They create companies that are streamlined and go on to make money and hire more people. But of course they also invest in companies that go completely bust and they sack off a lot of they lay off a lot of people, sell off a lot of assets and can actually end up killing a company. That happens as well. And if that happens that leaves them obviously the private equity people and the banks who've lent them a bunch of money and us because we're indirectly invested in these very badly needing a drink.