Private Equity Players

Explaining the Boom

Investors have flocked to private equity funds for the same reason that Willie Sutton said he robbed banks: because that’s where the money is. “The private equity markets have become an attractive alternative to the public markets,” says Tim Murphy, a partner in corporate finance and the mergers and acquisitions group at the Minneapolis-based law firm Lindquist & Vennum, PLLP. Trading in the stock market, local experts estimate, an investor might hope to earn between 8 percent and 15 percent returns. A private equity investment, on the other hand, might bring a profit of between 15 percent and 30 percent.

Investors have also become more familiar and comfortable with private equity as a means to achieve higher returns and fill the “alternate” investment category—which can include hedge funds, in addition to private equity—that most institutions need to diversify. “This has become an established, accepted alternate investment class,” Engler says.

There’s been a modest increase in the number of high-net-worth individuals and family offices investing in private equity. “Back in 1998 when we were raising our fund, the stock market was doing really well, and it was harder to convince individuals and family offices to look at alternate investments,” Musech says. Since then, though, “we’ve had a stock market that’s kind of treading water, and people are disenchanted with corporate scandals. High-net-worth people, family offices, and small community banks are looking for other places to put their money, and they’re more a part of our investor base than they were five years ago.”

In addition to the money they have raised in the past three years, many private equity groups have a backlog of cash that they raised but didn’t invest during the recession in the early part of this decade. During the downturn, few companies were on the market; business owners waited to sell until their earnings and prospects recovered. Companies were less attractive to buyers, including private equity firms. Now, though, companies are healthier, and that has led to higher valuations and more buying and selling.

It hasn’t necessarily led to better stock prices, though. As a result, companies are less likely to use their stock as currency for buying other companies (called a stock swap), because the stock is likely to be undervalued, and they may have to offer more of it to complete an acquisition. Businesses are also less likely to use initial public offerings to add liquidity when stock prices are low.