Tiger Sisters - Private Equity 101: Everything You Need to Know to Be Dangerous in 20 Minutes

Starting point is 00:00:00 What is private equity? And why is everyone always saying it's ruining everything that you love? Your favorite store closes, your hospital gets worse, and your childhood brands are unrecognizable. Chances are, private equity probably bought it. Private equity sounds intimidating like something only insiders understand, but it doesn't have to be. Welcome to Private Equity for Hot Girls. And Hot Girls is a mindset, obviously. In this episode, we're going to break down private equity. No jargon and no judgment. just cold, hard insights and facts into the most mysterious corner of capitalism and finance. If you love business drama or you love Succession, definitely listen to this episode all the way through.

Starting point is 00:00:38 I'm Sherey. I'm Gene. And we're the Tiger Sisters. We are your Wall Street and Silicon Valley Big Sisters. And we're a top 10 business podcast on Spotify, where we talk about money, power, and love. In this episode, we're going to break private equity down into five juicy parts. The first is what PE actually is. The second is how PE firms make their money, which is millions and billions. The third is what is a leveraged buyout,

Starting point is 00:01:20 also known as an LBO. The fourth is why does PE always get dragged in the media? And the fifth is what it means for you as a founder, customer, or an employee of a PE purchased firm. By the end, you'll understand why PE is always the villain in the media and whether or not that's actually fair. Please remember to like, follow, and subscribe.

Starting point is 00:01:41 If you subscribe or follow, you'll be updated whenever a new episode comes out. And if you're enjoying the show, make sure you leave a five-star rating on Apple Podcasts or Spotify. And for the real insider stuff and our deep dives, take a look at our newsletter, which is linked in the top description below. Let's get into it. This episode of Tiger Sisters is brought to you by Read AI. Yes, and it's not just another note taker. It's like an AI co-pilot that can read, transcribe, and summarize your meeting notes. It reads the energy and vibe of your meetings to give you the next smart steps.

Starting point is 00:02:18 I'm obsessed because it's like having a chief of staff that manages your inbox, your work meetings, basically your entire work life. Yeah, last week I missed a meeting and I was able to type, what did I miss? And Read AI was able to give me the top takeaways, the key points, and also the sentiment. It was kind of like magic. And it works across Gmail, Teams, Notion, Salesforce, Zoom, basically wherever you do your work. And you know me, I never give apps access to my Gmail because that's super private, but I actually made an exception for Reed AI because I personally know the founder, David Shim,

Starting point is 00:02:51 because we used to work together at Snapchat. And you guys might remember we actually interviewed David Shim on season three of Tiger Sisters when he was talking about his new startup, which is actually Reed AI. And now Reed has over 4 million users. Wow. Wow. And they're giving Tiger Sisters listeners a 30-day enterprise trial, which is worth $30 and that does not require a credit card to sign up. We don't know how long this 30-day free offer is going to last. So if you're at all curious, try it right now. Go to www. reed.a.i slash tiger sisters for a free 30-day extended trial and you don't need to put in your credit card. Sign up through our link because then they'll know that we send you.

Starting point is 00:03:31 We're obsessed with Reed AI and we think you're going to love it. too. And we're back. Okay, so this is part one. What even is private equity? Let's get into the definition. There are three things that define private equity. The first is private ownership. For the most part, private equity firms invest in companies that aren't on the public market. They are private companies. Second is control. When private equity companies invest or buy companies, they usually buy a majority stake of the company. The third is a turnaround mindset. The goal is to buy the company, increase the value, and sell it for a profit. Yeah, so think of it like this. Instead of buying a few shares of a company on Robin Hood or on the stock market, PE companies actually come in and

Starting point is 00:04:14 they buy either the whole company or a majority stake. And then they go ahead and make improvements, they increase efficiencies, and then they turn it around and sell it for a profit. So PE is different from VC venture capital because venture capital usually goes for the big bets, the earlier companies that are much riskier, whereas private equity companies generally target much larger companies that are bloated or have inefficiencies or real ways you can turn it around and then sell it for profit. Basically, these are larger companies that are more developed, but are fixer uppers. Right. So it's kind of like flipping a house. You come in, you see the potential, you renovate it, you flip it, you sell it for more. Think of brands like Burger King, Neiman Marcus, Dollar General,

Starting point is 00:04:57 Dunkin' Donuts, Dell Computers, so many different brands that you interact with on a week. weekly basis have been a part of private equity. Okay, Sherey, so let's move on to part two. How do P.E. firms actually make money? So there are two main ways P.E. firms make money. The first one is management fees, where they get typically 2% just to manage the P.E. Fund. So let's say P.E. Fund raises a billion dollars. That means they're getting $20 million a year just to manage the fund. The second one is the more important one. That's carried interest, and it's typically 20% on all the successful deals. And that's where the magic happens. So this sounds kind of complicated, but it's actually very common, and you'll hear people talk about it in 2 and 20.

Starting point is 00:05:36 They'll just say that phrase 2 and 20, talking about the management fees and also the carried interest. So, Gene, where do these private equity firms actually get their money from? Yeah, good question. So in this example before where I said, you know, this PE fund raised a billion dollars for their fund, they typically get that money from three different sources. The first one is LPs or Limited Partners, which is basically investors in the fund. These are typically big institutions like endowments, high net worth individuals, other sorts of investment funds. And pensions. And pensions, exactly.

Starting point is 00:06:09 The second source is the PE fund itself. They always put in a little bit of money themselves just to have skin in the game. Yeah. And a lot of limited partners like to see this because if you're the management team and you're charging those management fees, you also want to have some of your money invested into the firms as well. And the third one is debt, which brings us to the next section, which is leverage buyouts. When I first learned about private equity, I was most surprised to learn about the debt portion.

Starting point is 00:06:35 It's actually a lot of borrowing that's going on to then invest. So this is where LBO's leverage buyouts come into play. So what exactly is a leverage buyout or an LBO? This is where private equity firms take on debt. They borrow money to then buy a company. And once the company starts doing well, you know, the private equity firm starts to turn it around. it's making profit. They use that profit to then pay off the debt of the purchase, of the original purchase.

Starting point is 00:07:06 So that's where the leverage buyout comes in. Going back to the house flipping example that Gene gave before, if you think about a house, once you fix up the house and you rent the house out to people, you take in tenants, and then you use the monthly rent to pay off the mortgage. So that's a similar example of how an LBO type model would work with, everyday housing. Yeah, or if you want to put some numbers to it, you know, if you buy this house for $100,000, it's a million dollar house, you actually put in $100,000 of your own and you take on $900,000 of debt and then you actually improve the house and you make $100,000, you're actually

Starting point is 00:07:46 already making a return like of 2x on what you actually put in. So that's why LBOs are so powerful. The keyword is leverage, right? The idea that you're taking on a lot of debt so that you can do a lot more with a lot less of your own money. But it's not always rainbows and butterflies and sometimes an LBO goes wrong. So Shri, do you want to share an example? An example of that is Toys R Us. They took a $6.6 billion LBO out in 2005 and that was $5.2 billion of debt. And what ended up happening as the lower goes is that Toys R Us actually wasn't able to be turned around. It wasn't a successful company. And so they ended up having to pay like millions of dollars in just interest. Yeah. So they actually had to spend all their money servicing their debt. So they didn't really have

Starting point is 00:08:34 as much money left over to make the improvements that they needed to fight with, say, like Amazon, which was coming up at the time. And a lot of people were buying toys from Amazon. So rip. I actually remember that we used to go to Toys R Us all the time when we were kids. Yeah. It was like the place to go. Remember? You always used to be like, please. let's go to Toys R Us. It was amazing. It was a mecca, honestly. It was so gorgeous in there. All the lights and the colors. Yeah. So let that be a lesson. A lesson. Yeah. And by 2017, they were actually bankrupt. And that's the risk of taking on debt or leverage. It could work out really well and you could make millions and millions of dollars or it could really burn down the house.

Starting point is 00:09:18 Yikes. Dramatic. Mm-hmm. Okay. So next is part four. Why is private equity always? the bad guy, and we'll get to it right after this break. Quick pause, Tiger fam. This is Sheree, and we just dropped a brand new listener survey. It's different from the audience survey that you hopefully already filled out. It's 10 quick questions and 2 minutes max. Your support keeps the episodes free and publishing weekly. Why?

Starting point is 00:09:43 Because your answers tell future sponsors that Tiger Sisters is a show worth investing in. That means better partners, stronger episodes, and no random ads you don't care about. Tap the listener's survey link in the description right after this episode. Knock it out and help us keep building a podcast that feels made for you. Thank you from the bottom of our hearts for being the best part of Tiger Sisters. Now back to the show. And we're back. Okay, so Sheree, tell us, why is private equity always the bad guy?

Starting point is 00:10:11 I think in media, private equity, it gets a really bad reputation. There's a lot of movies and films and TV show that just shows like the slimyer parts of private equity. I think that's number one, how it's portrayed in media, but also how customers, consumers and employees are treated does not help with the reputation of private equity. The first reason why it gets a bad reputation is because of layoffs. Oftentimes when private equity firms are turning around companies, they have to do mass layoffs as a way to boost efficiency or improve the company, and that impacts day-to-day people and the employees.

Starting point is 00:10:44 I guess they don't have to do it, but that's typically a very strong lever for them to cut costs and therefore increase profits. Yeah. The second thing is prioritizing short-term benefits over long-term health. A lot of private equity firms have to be careful not to do this or else they risk improving the profits kind of artificially. Yeah. And this is, it actually depends on the PE fund and also kind of what size they are and what

Starting point is 00:11:11 their plan is for the company that they purchase because a lot of times, I guess maybe this is like another dirty secret of PE is that their goal is to actually improve. the efficiency of the company and then sell it to another PE fund. They just kind of want to hit a certain level of like profit and then move on to the next one. Right, because there's different sizes of PE funds and different types of companies that they buy. And so actually something that I learned when I was taking a private equity class at Stanford last year is that most of the exits, the exits of these PE firms is selling to another PE firm that takes on the company when it is grown to a certain size, which is how they make money.

Starting point is 00:11:54 The third reason why private equity gets a bad reputation is because of asset stripping. Like one lever they can pull in order to cut down cost is to sell things that the company owns. For example, if the company is a manufacturing company and they have really big machines or expensive machines, one thing that they can do is strip the assets and sell it, but that might not be good for the long-term health of the company, although it does raise profit. And the fourth reason why private equity gets a really bad reputation is because of industry sensitivity. A lot of health care firms or hospitals are actually controlled by PE firms.

Starting point is 00:12:33 And when incentives may not be necessarily aligned or there's different stakeholders in the entire equation, PE firms definitely their goal is to return money to the shareholder. And when that collides with hospitals or health care funds or education, it can get really sticky. Yeah, and I think especially when it comes to industries like hospitals, it's always just a really bad headline if it says like, you know, there's the, like we've talked about headline risk before on Tiger Sisters. There's just a lot of headline risk when it comes to these industries because you don't really want to be pointed to as like the evil company that laid off 30% of hospital workers. Right, right. Because there's a lot of downstream effects too that can ladder

Starting point is 00:13:14 up to that. And then the PE firm will inevitably be blamed for that. Right. And it's not always just sensitive industries like hospitals either. It's across all different industries. Like for example, think about vice media, which used to be a global media company. I remember they raised $1.6 billion, including from PE funds like TPG, and they weren't able to make it work. And they ended up declaring bankruptcy in 2023 and laying off hundreds of employees. And going back to the Toys R Us example, over 30,000 people lost their jobs when Toys R Us went under. Yeah, and there are so many examples in retail. So thinking about J. Crew, thinking about pay less, both of them went bankrupt at some point and ended up shutting hundreds of stores.

Starting point is 00:14:01 But to be fair, not all PE is bad. So look at what Blackstone did with Hilton, for example. They bought it, they improved it, they expanded it globally, and they actually took it public again. Yeah, they ended up making $14 billion on that deal, and they didn't have to do mass layoffs. Many times it comes down to incentives and style of the PE firm. It depends on the firm itself, how big it is, what industry it's in, and the strategy that they employ to turn around the companies. A lot of firms are able to do it and then sometimes they're not able to. Okay, Sherey, on to our last part, part five, which is how PE affects you as an employee or a customer.

Starting point is 00:14:38 So what can you expect if your company gets acquired by a PE firm? Yeah, I would say there are three main things. The first one is efficiency moves, aka typically cost cutting. And tighter budgets. Mm-hmm. The second one is new leadership. A lot of time these PE firms actually bring in people from outside the company. A lot of times they're actually operators that exist in the PE firm to come lead the new company.

Starting point is 00:15:01 Yeah, because PE firms, if they're turning around a company, they want to bring in people that they trust and know can do the job. And that they know will execute their strategy. True. And then the third one is restructuring, aka layoffs, which is to boost profits. ability. And as a customer, if a PE firm has acquired one of your favorite brands, you might see higher prices, worth service, and leaner offerings. Yeah, this reminds me of when my girlfriends and I heard that Zimmerman, you know, the Australian like dress brand for women, designer brand,

Starting point is 00:15:33 when they announced that they were PE acquired, we were like, oh shit, like better buy up all that Zimmerman now because next season, it's probably going to be worse quality and it's going to be more expensive because the PE fund is going to try to squeeze their profit margins and improve them. So that was just like a small way where like we were like, uh-oh. We know what's coming. Yeah, like time to buy up the kind of like vintage Zimmerman. But as devil's advocate, sometimes you do get better service. PE firms are known to cut the bloat and make things more efficient.

Starting point is 00:16:05 So that also trickles down to customer experience as well. Yeah, I would say a lot of times PE firms like what they say they're good at is improving operations. So if that's a big part of the business, that can be something that as a customer you might experience improved operations. Okay. And we'll wrap up this episode with our main takeaways after this break. We'll talk about is PE evil or just misunderstood. Okay. And we're back. So let's wrap up the episode. So Cherie, is P.E. evil or just misunderstood? My take personally is that private equity as a funding and like finance mechanism isn't inherently evil. Yeah, I would agree with that. I just think that if it's something that's touching like your

Starting point is 00:16:55 salad chain, your hospital, your favorite clothing brand, it's important to understand it so you can know how it affects your everyday life. And part of understanding it is actually knowing what private equity is, which now you guys do after this episode, and then understanding what are their goals, what are they optimizing for so that you can figure out how it affects you. Because when you follow the money, you end up seeing the incentives of the firms and what they're trying to go for. Yeah, and hot people understand incentives. And if you like this episode, please remember to like, comment, and subscribe. Please remember to follow and subscribe because then you'll be notified when a new episode drops. And if you're listening to us on Apple, Podcasts, or Spotify, please remember to give us

Starting point is 00:17:36 five stars. It really helps us get discovered and distribute our podcast to more listeners. And also subscribe to our newsletter, which is linked in the description, and follow us on our Instagram at Tiger Sisters Podcast. Thank you. Bye. Hey. Hey guys, quick break to let you know that we now have merch on sisters matcha.com. We have sweatshirts and t-shirts that we designed yourselves. Go check it out. And please rate us five stars on Spotify and Apple Podcasts. These ratings are so important for the distribution and survival of Tiger Sisters Podcast. Thank you for your support. Action. Say action makes me laugh. I'll say it. I can't say it anymore. Okay. And action. Okay, start out of work.

Starting point is 00:18:26 I had a moment yesterday. You take your moment. I have no words because yesterday I couldn't even breathe. Am I all red? Okay, it's fine. Action. Yeah. Okay.

Starting point is 00:18:50 I'll just look into the camera. This is bloopers.

Tiger Sisters - Private Equity 101: Everything You Need to Know to Be Dangerous in 20 Minutes

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.

Tiger Sisters - Private Equity 101: Everything You Need to Know to Be Dangerous in 20 Minutes