Private Equity: Acquisition and Restructuring of Companies

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Private equity is the acquisition of firms by private investors. The act is mostly developed in
the existence of a financial crisis within a business where the management works out for the
business survival or when investors of private equity feels that the company’s stock is
underperformance. The company’s management decides to look for an exit strategy to curb
the financial crisis affecting the company. They thus decides to look for an investment
opportunity where the company will realize more profits. They get the best alternative of
private equity financing.
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Private Equity
Abstract
Private equity is the act of buying and restructuring of companies by a private firm.
Following the purchase, the company ownership is made private in order to allow for
restructuring. Among the activities developed in the restructure process include cutting the
cost of production within the company, enhancing development through development new
products, enhancing growth and changing the company’s management. Private equity
includes the leveraged buyout that allows for private investor to take control of a firm. In
most cases, the investors consider investing in firms that are expected to improve and realize
significant growth in the future earning profits for the investor. The investor may consider to
sell the business later after it has realized a significant growth making profit in return. The
paper discusses factors involved with private equity financing. The discussion will
disseminate knowledge that is important for application in the business field.
Private Equity
Introduction
Private equity finance entails the act of raising equity capital by investors to
companies with high growth rate over a long period of time (Gatauwa, 2014, 15). The
financing strategy is mostly developed for small and medium business to whom access to
finances for funding their development is hard to acquire from family, friends and banking
institutions.
The financial strategy also helps to exploit opportunities and enhance growth by
providing financial support to investments facing difficulties in attracting financial support.

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Furthermore, the financial strategy has ensured the recovery of many businesses that were
initially struggling with financial challenges. As a result, many businesses have realized
continued growth and increased competitiveness in the business field. The investors who
undertake private equity finance always look out for businesses that promise high return in
order to attain their desires, that is, profits from the business. The finances can be offered at
different stages within the business growth which include starting, developing and already
developed businesses. In the funding the finances are categorized into groups, that is, seed
capital that is offered to beginning businesses and later stage capital that is offered to already
developed businesses.
Private equity finance offers the investor with a chance to transfer his or her capital to
a different business through the divestment process. As a result, investors are provided with
high chances of return since they can use the strategy to exit falling investments into a
thriving one. In addition, the investors are allowed access to debt financing that reduces the
corporate tax charged. As a result, the investors are assured of high profits from their
investments since they have few deductions to make.
Case description
What the case shows
The case shows the application of private equity within the business field where
private companies acquire existing firms through buyouts. A buyout entails the process of
acquisition of an existing firm through specialized investment of a small amount of equity
and huge investment in debt servicing. Under private equity investment, buyouts are
developed through the attainment of control over an existing firm by a private equity firm
(Kaplan & Stromberg, 2009, 121). In the case study, the private investor buys the shares of a
publicly owned firm transferring it into a private company. For example, Bieber Capital
bided Texas Utilities (TXU) for 40 Billion dollars claiming its ownership in early 2007. The
fee made included payment of a debt of 13 billion dollars that had been made by the company
to enhance its financial stability. The investment was valued as one of the best during the
year since it was expected to generate huge returns owing to the company’s size, market
share and favorable investment conditions, that is, low interest rate, availability of debt for
servicing the investment and high stock market observed in the year 2007. In 2006, a group
of investors acquired the hospital chain (HBA). The team spent 32 billion dollars developing

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mega buyout. The buyout services often take place when interest rates are low, credits for the
purchase are available and when there is a rise in the stock market. For example, due to the
high prices for target companies the borrowing rate increased with the availability being
ensured and the interest rates for the borrowed money remaining low. The debt availability
was ensured by the presence of junk bonds that were being offered by portfolio companies
(Gompers & Kim, 2014, 2).
A practical example can be derived from the application of Taylor rule in the case
study where it determines the monetary policy, taking into consideration the price stability
and the economic output. To calculate the monetary policy, the following Taylors rule
formula is applied: nominal fed fund rate= real federal funds rate + rate of inflation + 0.5
(rate of inflation – target rate of inflation) + 0.5 (logarithm of real output – logarithm of
potential output). This is simply presented as i= r* + pi + 0.5 (pi-pi*) + 0.5 (y-y*). However,
in the case study, the emphasis is given to nominal interest rate simply derived via the
formula Rf = 4% + 1 (inflation – 2%) + 0.5(output). This can be analyzed in that an increase
in inflation above 2% means an expected increase in nominal interest rates with over one for
one (what do you mean by over one for one). In addition, the lending power increased in
the year 2007 helping investors to easily access debt financing for their investments. The
accessibility can be identified from the increase in amount borrowed. In the year 2007 the
amount borrowed was 4.1 trillion dollars owed to an increase in the number of borrowers
(Gompers & Kim, 2014, 2).
Another practical example is the Dell LBO equity finance. As seen from the case
study, the Dell equity which is $ 24, 156 comprises of 30-40% of the LBO financing. The
largest percentage of LBO financing is made up of Debt. In this case, the Dell LBO had a
debt of $9,034. To determine whether an investment is worth buying out, the acquisition firm
calculates the internal rate of return with a minimum of 30% but for larger deals it can even
be 20%. As it can be witnessed from the case, it is important for the acquiring company to
evaluate the risk ratio (debt-equity ratio). This is a leverage ratio which computes the debts
and liabilities against equity. Debt to equity ratio is given the following formula; Debt to
equity ratio =total liabilities/total equity. In the case of Dell LBO
Total liabilities = $ 24,784
Total equity = $ 24,156
Debt to equity ratio = 24784/24156