Money Rehab with Nicole Lapin - WTF is PE? Decoding Private Equity and How Investors Make Money

Episode Date: June 27, 2024

What do LeBron James, Kim Kardashian and Will Smith have in common? They’re all investors in private equity. But to invest in PE, do you need to be a gazillionaire, or a celebrity… or both? Today, Nicole explains what PE is, and who can benefit from PE returns.

One of the most stressful periods of my life was when I was in credit card debt. I got to a point where I just knew that I had to get it under control for my financial future and also for my mental health. We've all hit a point where we've realized it was time to make some serious money moves. So take control of your finances by using a Chime checking account with features like no maintenance fees, fee-free overdraft up to $200, or getting paid up to two days early with direct deposit. Learn more at Chime.com slash MNN. When you check out Chime, you'll see that you can overdraft up to $200 with no fees. If you're an OG listener, you know about my infamous $35 overdraft fee that

I got from buying a $7 latte and how I am still very fired up about it. If I had Chime back then, that wouldn't even be a story. Make your fall finances a little greener by working toward your financial goals with Chime. Open your account in just two minutes at Chime.com slash MNN. That's Chime.com slash MNN. Chime. Feels like progress. Banking services and debit card provided by the Bancorp Bank N.A. or Stride Bank N.A. Members FDIC. SpotMe eligibility requirements and overdraft limits apply. Boosts are available to eligible Chime members enrolled in SpotMe and are subject to monthly limits. Terms and conditions apply. Go to Chime.com slash disclosures for details.

I love hosting on Airbnb. It's a great way to bring in some extra cash, but I totally get it that it might sound overwhelming to start or even too complicated if, say, you want to put your summer home in Maine on Airbnb, but you live full time in San Francisco and you can't go to Maine every time you need to change sheets for your guests or something like that. If thoughts like these have been holding you back, I have great news for you. Airbnb has launched a co-host network, which is a network of high quality local co-hosts with Airbnb experience that can take care of your home and your guests. Co-hosts can do what you don't have time for, like managing your

reservations, messaging your guests, giving support at the property, or even create your listing for you. I always want to line up a reservation for my house when I'm traveling for work, but sometimes I just don't get around to it because getting ready to travel always feels like a scramble, so I don't end up making time to make my house look guest-friendly. I guess that's the best way to put it. But I'm matching with a co-host so I can still make that extra cash while also making it easy on myself. Find a co-host at Airbnb.com slash host. I'm Nicole Lappin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab. What do LeBron James, Kim Kardashian, and Will Smith all have in common?

Well, they're investors in private equity. Private equity is not just for celebrities, though. P.E. has been a staple on Wall Street for decades, and some of the biggest financial institutions like Blackstone, BlackRock, and Goldman Sachs have also been involved with private equity. But to invest in PE, do you need to be a gazillionaire or a celebrity or both? Today, I'm going to be talking about what PE is and who it's for. But let's start with the basics. At its core, private equity refers to investments made directly into private companies or the buyout of public companies that result in the delisting of public equity. And we've actually heard an example of this. You might remember my interview with Neil Parekh, one of the Casper co-founders

who talked about when their company went from a private company to a public company and then back to being a private company after being acquired by PE firm Durational Capital Management. At the most basic level, private equity firms invest in businesses that are not listed on any public stock exchange. They often buy entire companies, make them more profitable, and then later sell them for more than they bought them for. Private equity firms raise funds from investors called limited partners or LPs. And for private equity, investors aren't always wealthy folks. Sometimes investors are pension funds or insurance companies or endowments.

These PE funds then use that money to buy stakes in private companies or public companies that they plan to take private. So what is the draw for investors? Well, private equity investments are typically long term and can offer big returns often higher than those from public stock markets however these investments also come with higher risks and are usually less liquid meaning it's harder to sell them quickly you can't just open your brokerage app and sell your shares like you would a public company and your money is often locked up for a long term typically seven to ten years so we just talked about the investors but what's in it for the pe firm itself typically private equity firms charge a management fee and a performance fee. The management fee is usually around 2% of the committed capital, which goes toward the

operational costs of managing the actual fund. The performance fee, often called carried interest or just carry, is around 20% of the profits generated from those investments. So this fee structure really incentivizes the private equity firm to maximize returns for their investors, because if their investors do well, they do well. You might be asking yourself, how is this different from venture capital? Great question. Venture capital is actually a subset of private equity. VC firms typically invest in startups or early stage companies that have high growth potential but are also high risk. Think of companies like Uber or Airbnb before they became household names. Private equity firms make money in a few different ways.

One of the most common methods is through leveraged buyouts, also known as LBOs. In an LBO, the private equity firm buys a company using a significant amount of borrowed money. The idea here is to use the company's own assets and future cash flows to pay off that debt. This can mean more returns later on, but it also seriously increases the risk if the company doesn't do well. Another strategy private equity firms use to make money is called growth capital. This involves investing in companies that are looking to expand but need money to do so. These are typically companies that are already established, profitable, but just need more funding for new projects, acquisitions, or to enter new markets. So how do private equity firms

add value to companies they're investing in? It's not just about providing money. Private equity companies also take an active role in the management of their portfolio companies. They might bring in new leadership, streamline operations, or help expand into new markets. The goal here is to improve a company's performance and profitability, making it more attractive for a future sale or a public offering. So let me give you an example of what this might look like. Imagine a private equity firm buys a retail company. They might replace the management team, revamp the company's online presence, and renegotiate supplier contracts to cut costs. After a few years of improvement, they sell the company's online presence and renegotiate supplier contracts to cut costs. After a few years of improvement, they sell the company at a much higher price than they paid for it, generating a hefty return for their investors. This is the happily ever after scenario that PE

firms shoot for. Now, who can invest in private equity? Unfortunately, or maybe fortunately, private equity investments aren't open to everyone. PE is typically reserved for accredited investors. These are people or institutions that meet certain financial criteria, ensuring that they can handle the risks involved. This means that for most everyday investors, direct access to private equity firms might be out of reach. So then why should you care about private equity firms as a new investor, you might ask? Well, understanding private equity can give you a broader perspective on financial markets and investment opportunities. Even if you can't invest in private equity directly, knowing how it works can help you make more

informed decisions about your investments. For example, if you're investing in public companies, it might be useful to know which ones are targets for private equity buyouts or which companies have private equity backing. These factors can influence stock performance and give you insights into market trends. For today's tip, you can take straight to the bank. If you are really feeling PE, there are ways to get exposure without being an accredited investor. There are some platforms that allow smaller investors to pool their money together and invest in private companies, though they often come with higher minimum investment requirements and fees. And some mutual funds and ETFs also invest in private equity or companies that are heavily involved in

PE deals. One of the most stressful periods of my life was when I was in credit card debt. I got to a point where I just knew that I had to get it under control for my financial future and also for my mental health. We've all hit a point where we've realized it was time to make some serious money moves. So take control of your finances by using a Chime checking account with features like no maintenance fees, fee-free overdraft up to $200, or getting paid up to two days early with direct deposit. Learn more at Chime.com slash MNN. When you check out Chime, you'll see that you can overdraft up to $200 with no fees. If you're an OG listener, you know about my infamous $35 overdraft fee that I got from buying a $7 latte and how I am still very fired up about it.

If I had Chime back then, that wouldn't even be a story. Make your fall finances a little greener by working toward your financial goals with Chime. Open your account in just two minutes at Chime.com slash MNN. That's Chime.com slash MNN. Chime. Open your account in just two minutes at Chime.com slash MNN. That's Chime.com slash MNN. Chime. Feels like progress. Banking services and debit card provided by the Bancorp Bank N.A. or Stride Bank N.A. Members FDIC. SpotMe eligibility requirements and overdraft limits apply. Boosts are available to eligible Chime members enrolled in SpotMe and are subject to monthly limits. Terms and conditions apply. Go to Ch chime.com slash disclosures for details.

I love hosting on Airbnb. It's a great way to bring in some extra cash, but I totally get it that it might sound overwhelming to start or even too complicated if, say, you want to put your summer home in Maine on Airbnb, but you live full time in San Francisco and you can't go to Maine every time you need to change sheets for your guests or something like that. If thoughts like these have been holding you back, I have great news for you. Airbnb has launched a co-host network, which is a network of high quality local co-hosts with Airbnb experience that can take care of your home and your guests. Co-hosts can do what you don't have time for, like managing your reservations, messaging your guests, giving support at the property, or even create your listing for you. I always want to line up

a reservation for my house when I'm traveling for work, but sometimes I just don't get around to it because getting ready to travel always feels like a scramble, so I don't end up making time to make my house look guest-friendly. I guess that's the best way to put it. But I'm matching with a co-host so I can still make that extra cash while also making it easy on myself. Find a co-host at I can still make that extra cash while also making it easy on myself. Find a co-host at Airbnb.com slash host. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin.

Money Rehab's executive producer is Morgan Levoy. Our researcher is Emily Holmes. Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you.

No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.