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Private Equity Funds

According to the Federal Deposit Insurance Corp., banks grew their loan balances by $178 billion during the second quarter, compared with $38 billion a quarter earlier. That’s the largest lending expansion since banks lent $203 million during the fourth quarter of 2007...

According to the Federal Deposit Insurance Corp., banks grew their loan balances by $178 billion during the second quarter, compared with $38 billion a quarter earlier. That’s the largest lending expansion since banks lent $203 million during the fourth quarter of 2007.

After years of sinking loan balances, lending has finally surpassed its 2007 levels. However, since the spread between the Federal Funds rate and the average lending rate is higher than normal, most of the new loans issued are going to consumers and businesses who can afford to pay above-market interest rates.And that leaves a big gap for alternative lenders to fill—such as private equity firm Kohlberg, Kravis, Roberts & Co. L.P. (KKR)—our Spotlight Stock this month.

A private equity firm raises funds to invest in companies via leveraged buyouts, venture capital and growth capital. In return, they receive management fees, a share in the profits and usually a controlling ownership position. Most of them exit their investments through an initial public offering (IPO), a merger or acquisition, or a recapitalization (distributing cash to the shareholders or raising debt or other securities to fund the distribution).

But lest you think that the need for private equity firms will disappear as the economy grows stronger, I urge you to think again. In fact, one of the most popular tiers for private equity investing is middle-market firms—small and mid-sized companies, with under $500 million in annual revenues—the very same companies that find it very difficult to obtain bank loans, no matter the economic cycle.

Last year, 873 private equity funds raised a total of $454 billion, the highest level since 2008. And they also saw the largest number of equity-backed buyout exits, with 1,348 funds exiting investments worth $303 billion. Bain & Capital estimates that private equity firms are sitting on more than $1 trillion, just waiting for the right investment. Bain also says that U.S. private equity firms own just 5% of all U.S. businesses with revenues exceeding $10 million. That sounds like a huge market opportunity!

The top private equity firms and the capital they raised as of 2014 are:

• The Blackstone Group, $65.7B

• TPG Capital, $59.0B

• Apollo Management, $48.0B

• Carlyle Group, $62.9B

• Kohlberg Kravis Roberts, $54.5B

The opportunity for investors is in the IPOs that are generated when private equity firms exit their investments, and in the firms themselves. According to Ernst and Young, in the first quarter of 2014, private equity exits led to 46 IPOs, totaling $17.4 billion—double the amount in 2013’s first quarter.

Investors who want to actively participate in private equity funding are usually limited to those lucky folks who have more than a million to invest. However, that may be changing. Last year, the Carlyle Group launched a new product to allow investors with $50,000 access to Carlyle’s private equity funds. And KKR is working on a product that may attract investors with as little as $10,000 to invest in private equity funds. A stumbling block arises from the Investment Company Act of 1940, which limits individual private equity investors to those who already have at least $5 million in investments. Both Carlyle and K.K.R. are attempting to appeal the definition of “accredited” investors. Stay tuned for further updates.

Nancy Zambell has spent 30 years educating and helping individual investors navigate the minefields of the financial industry. She has created and/or written numerous investment publications, including UnDiscovered Stocks, UnTapped Opportunities, and Nancy Zambell’s Buried Treasures under $10. Nancy has worked with MoneyShow.com for many years as an editor and interviewer for their on-site video studios.