An Explanation of Private Equity

Here was a man with thirty years of experience in the Private Equity business. Here was a graduate of Harvard undergrad, as well as Harvard business, who serves as the treasurer of the school. Yet, Paul Finnegan stood before the students of the Business and Investment Club as a father, one who had seen his three children attend ETHS. To the admiring looks of the current students, Finnegan declared that he thinks the world of this high school. With his audience already won over, Finnegan launched into the profession he was an expert in: Private Equity.

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Murmurs and confused faces scuttled through the attendees; just what was Private Equity? Finnegan divulged that he didn’t know himself until college. Private Equity is a private pool of money that is used to buy companies. His company, Madison Dearborn, invests in companies for five to seven years, then either take the company public, sell it to a competitor, or sell it to another Private Equity fund. Madison Dearborn partners with CEO’s to grow and expand the businesses they purchase. As the interest in the room proliferated, Finnegan reported that Private Equity is a maturing business practicum, and that many business students (including the young entrepreneurs in the room before him) could be headed for it.

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As the co-Chief Executive Officer at Madison Dearborn, Paul Finnegan focuses on three general types of companies: early stage, which are small companies in a little known industry led by an entrepreneur, growth, which are companies in a rapidly growing industry with an experienced CEO at the reins, and later stage companies, who are in a mature industry. In order to work with these companies, Madison Dearborn typically utilizes a strategy called a leverage buyout (LBO), where they use some debt, along with equity, to purchase a company. Upon the large screen at the front of A241, Finnegan showed a model of two houses, one “before” and one “after” the transaction. He explained that Madison Dearborn works to align the interests of the owners and managers, and to improve the asset; therefore, when the “after” house is sold, there is a greater value in the equity and the debt has been paid down. In order to fundraise the money to carry out such a transaction, Finnegan elucidated the investment cycle: Madison Dearborn looks for a 25% return on investments. They collect money from pension funds, endowments, and high worth individuals, money that goes into a fund that is used for the transaction.

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At that point, the members of the investment club knew what Madison Dearborn did; Finnegan then began to explain who they were. Originally, they were part of the North Chicago Bank, but spun out to form their own firm. Their focus includes deals in the following sectors: consumer, healthcare, financial and transition services, telecommunications, media and technology, business and government services, and basic industries. Madison Dearborn is a highly focused establishment; they have only one office, in Chicago. One of the most impressive aspects of the firm is the stability of the employees: the managing directors at MD have an average of more than fifteen years of experience. Also, Finnegan made sure to include that the investors are sure to invest money in themselves when doing business deals; having “skin in the game” reflects personal confidence that the company prides itself on.

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With all of the Madison Dearborn background provided, Finnegan moved to describe the life cycle of a transaction. When MD wants to facilitate a transaction, they approach investment bankers, deal brokers, and existing relationships in their clientele network. Usually, they go to the company, where the management team there will give a presentation. The first stage thereafter is to submit a non-binding bid. Second comes the the binding, fully-financed transaction proposal. The two parties agree on a price, and from there on MD works to monetize the company to the best of its ability.

Once the life of a transaction had been detailed, Mr. Finnegan spoke briefly about the different qualifications necessary to work in different sectors of finance. To work in venture capital, usually an MBA is needed, and a technology background is handy for understanding emerging industries. To be in growth equity, applicants usually have worked two years in an investment banking analyst program, giving them industry knowledge and an understanding of technical issues. The third sector Finnegan talked about was management buyouts: an investment banking program is a must, but industry knowledge isn’t as important as it is in the fields that handle the early stage companies.

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As soon as Finnegan opened the room up to questions, a number of young, entrepreneurial hands shot up. The attendees learned that the debt markets were currently not very good, and that firms like MD were in selling mode. Finnegan again re-emphasized the importance of the management of the client he’s working with having “skin in the game”. After facing a barrage of questions, Finnegan turned one back on the club members: when is the most dangerous time to make a deal? As the members speculated, Finnegan revealed that the most dangerous time is immediately after a great deal, when the deal-maker thinks he has a, “hot hand”. This act of hubris can cause a person to take too much risk, and it can hurt the company.

Stepping aside from Madison Dearborn, Finnegan ended by talking about his non-profit/volunteer work. He remains active as Treasurer of Harvard University, a position that dates back to 1636, Besides Harvard, Finnegan spoke about his work with Teach for America, and how he works to fix education inequality in our country. Teach for America, like Harvard, is run by a woman, which Finnegan believes is excellent. He believes women leaders to be loyal, as well as having strong decision-making skills. Plus, they don’t have the macho issues he sees many times in business executives. His last message to the Investment Club was that more women should be in leadership positions; doing so would undoubtedly improve our country.

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This post was written by Ben Osterlund. Photos by Benjamin Silverman, edits by Noah Silverman.

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