Why do private equity companies use leverage when buying companies?

By using significant amounts of leverage (debt) to help finance the purchase price, the private equity firm reduces the amount of money (the equity) that it must contribute to the deal.

How much leverage do private equity firms use?

That’s the first play many PE firms will run–even if they buy your company for cash. It’s an industry standard to see PE firms borrow up to 2-4 times EBITDA, or the net profits, of a business. Sometimes, that number is even higher.

Does leverage increase risk?

At an ideal level of financial leverage, a company’s return on equity increases because the use of leverage increases stock volatility, increasing its level of risk which in turn increases returns.

Who invests in private equity?

At a basic level, private equity involves three parties: The investors who supply the capital. The private equity firm that manages and invests that money via a private equity fund. The companies the private equity firm invests in.

What are PE firms?

A PE firm is a financial buyer that invests in private companies of all sizes. Some firms invest across many industries, while others are focused on specific industries such as technology or energy services. They are a good alternative if you want to sell your company without inflicting severe and immediate change.

What are private equity investments?

For most institutional investors, private equity investments are made as part of a broad asset allocation that includes traditional assets (e.g., public equity and bonds) and other alternative assets (e.g., hedge funds, real estate, commodities).

How are private equity firms structured?

Private equity firms are structured as partnerships with one GP making the investments and several LPs investing capital. All institutional partners of the fund will agree on set terms laid out in a Limited Partnership Agreement (LPA). Some LPs may also ask for special terms outlined in a side letter.