A handy private equity cheat sheet
Want to better understand the industry? Here's a quick guide to some of the arcane terms in the multibillion dollar world of private buyouts.
NEW YORK (CNNMoney.com) -- If you haven't been paying attention to private equity - now's the time to study up.
Private equity has become a driving force of the economy - both in the United States and around the world. Buyout firms, which purchase established companies with their own funds and borrowed money, accounted for one-fifth of last year's record $3.8 trillion deal activity.
And companies being taken private these days are increasingly well known household names.
Companies snapped up in the first three months of this year alone include: Servicemaster (Charts), the owner of Terminix pest control; discount retailer Dollar General (Charts); and Pinnacle Foods, whose brands include Duncan Hines and Mrs. Buttersworth's syrups.
Here's a guide to some of the terms that will help you better understand the private equity world:
Carried interest. The cut private equity firms take when the funds they manage make a profit. This serves as an incentive for fund managers, who usually take home about a 20 percent slice of profits. The remaining 80 percent of profits gets distributed to investors.
Club deals. When private equity firms team up to go after large targets. Some private equity firms say these deals help spread out risk - the more buyers, the less exposure an individual firm has in case a deal goes bad. There are concerns, however, that disagreements among the firms will arise when it comes to managing such investments.
Distressed debt. The bonds of firms that have filed for, or are on the verge of, bankruptcy. Some private equity shops specialize in purchasing these companies on the cheap and turning them around. This is expected to become a hot area if credit markets tighten and it becomes more difficult for companies to refinance their debt.
General partner. The manager of a private equity fund. This can refer to the private equity firm itself ,or the senior partners of a private equity firm. Some of the biggest private equity firms include Blackstone Group, Kohlberg Kravis Roberts, Carlyle Group, TPG (formerly Texas Pacific Group) and Bain Capital.
Leveraged buyout. When a company is bought with mostly borrowed money. The loan is frequently secured by the assets of the target firm. Private equity firms specialize in these transactions, which don't require them to invest a lot of their own money. After a company is bought, private equity firms may overhaul the business with the aim of selling it at a profit or taking it public within three to five years; or they may split up the company and sell off divisions to pay off the loans.
Limited partners. The investors in a private equity fund. These are usually institutional investors like pension funds and endowments looking for better returns than those generated in public markets. More investors have flocked to private equity in recent years as it has become a more mature investment vehicle.
Management fee. An annual fee investors pay to general partners to manage a private equity fund. The fee is usually 1 to 3 percent of the total commitment an investor has made to a fund. The amount private equity firms generate from these fees has risen as overall fund sizes have exploded. A private equity firm that has raised a $20 billion fund can expect to rake in $200 million to $600 million in management fees each year.