Private Equity
Private equity is the business of buying control of companies with a mix of a fund's capital and borrowed money, improving them over four to six years, and selling them for a multiple of the equity invested. The funds are raised from institutions, run by general partners paid a fee and a share of profits, and the model — leverage, operational change, a timed exit — has owned much of the payments industry since 2015.
- Also known as
- PE, Buy-out fund, Private equity fund
- Used at
- buy-outs of mature, cash-generating companies; carve-outs from corporates; take-privates of listed companies; in fintech, payments processors, software providers and, more carefully, lenders
- Binding
- the fund's limited partnership agreement with its investors (a ten-year life, a five-year investment period), and each deal's documents
- Typical economics
- a management fee of 1.5–2% of committed capital and carried interest of 20% of profits above a hurdle (usually 8% a year); target returns of 2–3× and 20%+ IRR on each deal; global assets under management above $8 trillion across private markets
- Typical fintech record
- the 2019–2023 wave — Worldpay (GTCR, 55% at $18.5bn), Nets (Hellman & Friedman, 2018), Nexi's consolidation with Advent and Bain, and dozens of mid-market payments platforms — plus the 2022–2023 take-privates of listed fintechs at prices far below 2021's
- Parties
- the general partner (the firm), the limited partners (pension funds, insurers, sovereign funds, endowments), the portfolio companies' management, the lenders, and the buyers at exit
How private equity works in practice
A firm raises a €2bn fund from institutions who commit capital for ten years. Over five years it buys ten to fifteen companies, each for 40–60% equity and the rest debt secured on the company. For each it installs a board, a plan and an incentivised management team, and pursues the levers that raise the exit value: revenue growth, margin improvement, add-on acquisitions, and debt paid down from cash flow. In years four to six it sells, returning capital and profit to the investors; the firm keeps 20% of the profit above the hurdle, which is where its partners' wealth comes from.
The return has three sources, and the honest analysis separates them. Leverage: the same growth on less equity is a higher return. Operational improvement: EBITDA that rose because the company got better. Multiple expansion: selling at a higher multiple than buying, which is the market's gift and not the firm's. A deal that made 3× from multiple expansion in a rising market is not the same as one that made 3× from EBITDA growth, and the firms that survived 2022 were the ones whose returns had come from the second.
In fintech the model fits payments — stable, cash-generative, consolidating — and fits lenders badly, because a lender's balance sheet is its business and cannot be levered twice. The regulator adds a fourth constraint: it approves the fund as a controller, asks about the debt, and caps the dividends that service it.
Example
A fund buys a payments software company for €200m in 2020: €90m of debt, €110m of equity. It hires a CFO and a head of sales, buys two add-ons for €30m (funded by €20m of further equity and €10m of debt), migrates them to its platform, and raises EBITDA from €20m to €34m by 2025. It sells for €374m — 11× — with €70m of debt outstanding: €304m of equity on €130m invested, 2.3×, a 19% IRR. The attribution: €70m of the gain from EBITDA growth at the entry multiple, €34m from the exit multiple being one turn higher, and the leverage that turned a 1.9× enterprise-value gain into a 2.3× equity return. The firm's carry on the deal is about €33m; the limited partners receive €271m.
Common mistakes
- Returns attributed to skill that came from the multiple, and a fund that cannot repeat them. - Leverage sized for 2021 that has to be refinanced in 2023. - Buying a lender as if it were a software company, and discovering the regulator's view of the debt. - Add-on acquisitions bought faster than the platform can integrate them. - Management equity that rewards the sponsor's leverage rather than the company's growth — and a team that leaves the day it vests.