Virtually every company, public or private, has a capital structure made up of equity (stock) and debt (bank loans, bonds, etc.). When a private equity firm acquires a company, they usually invest using equity from their fund(s) and loans normally provided by banks or the bond market.

Within venture and expansion cases, there is normally no leverage.

Within the buyout segment, private equity firms, more often than not, use debt to acquire portfolio companies, but this debt is maintained at the portfolio company level. The typical capital structure of the companies acquired by a private equity fund is approximately 60 percent debt and 40 percent equity (though this proportion can vary based on the cost of credit, the economic outlook, and the nature of the business).

Higher levels of debt will increase risk. It will also increase the potential for high return on the investors’ equity (and vice versa). Studies show that the leverage level is an important factor in mitigating agency problems because management needs to focus on the right goals, and reduces capital spending on non-bottom-line improving items.

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