A recent Wall Street Journal article addresses reader comments regarding the uptick in the cash balances held by private equity firms. Below are samples of reader questions and corresponding WSJ responses:
- Are these companies keeping cash in the bank and then borrowing to fund acquisitions? A bit of both, says WSJ. Private-equity funds, it says, use “lots of debt, or leverage, on top of their equity when they buy a company. This boosts the returns to their equity investment.”
- The effect of leverage on private equity returns, says WSJ, is an important point but one that can cause confusion. It explains, “Private equity applies leverage, by which we mean debt, to the companies it buys—but not at the level of its funds.”
- Private equity makes most of its investments among small to medium-sized companies, which typically offer higher returns. So, would private equity investments outperform investments in public securities of similar size? The article cites data showing that private equity outperformance is similar for S&P 500 stocks and smaller stocks, but they underperformed mid-caps at times during the late-nineties and mid-2000s.
- Can private equity returns be trusted if they are based on theoretical company valuations? According to consultants at Bain & Company, the article reports, about 90% of the capital invested in 2009 or before by private equity is in deals that have been fully or partially sold, which means they have “market-verified values.”