The Private Equity Business Model

In this chapter we explore the extent to which the private equity business model (PEBM) is robust or fragile. The PEBM is driven by financial leverage because it depends upon high levels of debt to equity funding to finance the acquisition of target firms. Once a firm is acquired by a private equity partnership, it is subject to a turnaround strategy to boost return on capital and thereby generate a higher market valuation from analysts. In circumstances where the value of an acquired firm (asset) inflates, it can be sold on so that the debt can be repaid and the remaining surplus returned to the private equity limited and senior partners. During the 1990s the emergence of the private equity business model promised sparkling returns, well above the benchmark internal rate of return (IRRs) for equity investors.