how private equity creates value
by the time a private equity firm acquires a company it will already have a plan in place to increase the investment s worth that could include dramatic cost cuts or a restructuring steps the company s incumbent management may have been reluctant to take private equity owners with a limited time to add value before exiting an investment have more of an incentive to make major changes the private equity firm may also have special expertise the company s prior management lacked it may help the company develop an e commerce strategy adopt new technology or enter additional markets a private equity firm acquiring a company may bring in its own management team to pursue such initiatives or retain prior managers to execute an agreed upon plan the acquired company can make operational and financial changes without the pressure of having to meet analysts earnings estimates or to please its public shareholders every quarter ownership by private equity may allow management to take a longer term view unless that conflicts with the new owners goal of making the biggest possible return on investment industry surveys suggest operational improvements have become private equity managers main focus and source of added value 2122but debt remains an important contributor to private equity returns even as the increase in fundraising has made leverage less essential debt used to finance an acquisition reduces the size of the equity commitment and increases the potential return on that investment accordingly albeit with increased risk private equity managers can also cause the acquired company to take on more debt to accelerate their returns through a dividend recapitalization which funds a dividend distribution to the private equity owners with borrowed money dividend recaps are controversial because they allow a private equity firm to extract value quickly while saddling the portfolio company with extra debt 23 on the other hand the increased debt presumably lowers the company s valuation when it is sold again while lenders must agree with the owners that the company will be able to manage the resulting debt load 