Private Equity

Private Equity

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Companies looking to raise capital can take out loans, issue stock or sell bonds. The private equity market offers an alternative to these more conventional methods of raising capital.
In the past, the private equity market was often considered murky and difficult to access, but today the lure of private equity is attracting qualified businesses and investors alike. In the third quarter of 2021, private equity deal value reached a new record, topping $787 billion for the year.
Private equity (PE) refers to a constellation of investment funds that invest in or acquire private companies that are not listed on a public stock exchange. So-called PE funds may also buy out public companies, take them private, and then restructure them for potential future growth.
Another way to define private equity is as a form of financing where public or private companies accept investments from a PE fund. Typically, private equity invests in mature businesses in more conventional industries in exchange for an equity stake in the company.
In the past, private equity funds haven’t always been regulated in the same way as other market participants. These days, however, they tend to be scrutinized more rigorously.
PE funds often target a specific type of company based on where that company is in its lifecycle. For example, different private equity funds may specialize in younger firms with promising futures, well-established companies with reliable cash flows, or failing companies that need to be restructured.
In the latter scenario, a PE fund might buy out all the shares in a weak company with the goal of delisting the company, changing the management and improving its financial performance. The goal would be to sell it to another company or take it public again in an initial public offering ( IPO ).
Private equity is considered to be an alternative investment class or alternative asset. Only institutional investors and accredited investors are eligible to put money into a private equity fund.
Accredited investors are deemed to have the financial know-how needed to evaluate these types of more opaque investments, and the funds available to be able to handle potentially large financial losses. Accredited investors must meet several criteria, including a specific earned income, net worth, and certain professional certifications, among other things.
Because of these strict qualifications, typical investors for private equity funds usually include institutions like pension funds and banks, or individuals like investment managers or people with a high net worth.
Private equity firms became popular during the 1970s and 1980s as a way for companies that weren’t doing well to make money in a way that avoided public markets.
They make their money by charging management and performance fees from investors within a private equity fund. PE firms typically include the following individuals:
Members of a specific firm usually agree on a set of terms laid out in a Limited Partnership Agreement (LPA), which designates payments and responsibilities for everyone involved.
Like hedge funds , the most common fee structure is two and twenty. Under this compensation structure, the PE firm charges an annual management fee of 2% of total assets under management (AUM)—even when the fund isn’t successful—and 20% of proceeds after break-even are received by GPs.
Something called a “hurdle rate” may also be included as a way of defining a minimum rate of return to achieve before accruing carried interest to GPs. LPs, on the other hand, receive all fund proceeds, minus the GP payment.
Venture capital (VC) and private equity work somewhat similarly—but there are a few key differences between these two approaches to funding.
Companies like Apple ( AAPL ), Toys R Us, RadioShack, and Payless Shoes have all had run-ins with the private equity industry. That’s not surprising, since many of the world’s top private equity firms are based in the U.S. Some popular ones include:
Private equity investing isn’t directly available for average investors who aren’t accredited.
There are options for investors who don’t qualify for direct private equity investing but still want exposure. Several of the largest private equity firms—like the Carlyle Group (CG), Kholberg Kravis Roberts (KKR), and the Blackstone Group (BX)—are publicly traded.
There are also exchange-traded funds (ETFs) and mutual funds that invest in the publicly traded shares of private equity firms. Use your online brokerage account to buy the funds that interest you, or open a new one to get started.
Although private equity investments have enjoyed strong historical performances, the best portfolio is a well-rounded one.
Even if you do decide to include some private equity holdings as part of your portfolio, it’s important to understand that these types of investments do come with risk. Not only can it take years for you to realize the full value of your investment, if the company doesn’t increase its value as expected, you could break-even or see a loss on your investment altogether.
Rebecca Baldridge, CFA, is an investment professional and financial writer with over twenty years of experience in the financial services industry. In addition to a decade in banking and brokerage in Moscow, she has worked for Franklin Templeton Asset Management, The Bank of New York, JPMorgan Asset Management and Merrill Lynch Asset Management. She is a founding partner in Quartet Communications, a financial communications and content creation firm.

Troy Segal is an editor and writer. She has 20+ years of experience covering personal finance, wealth management, and business news.

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Dr. JeFreda R. Brown is a financial consultant, Certified Financial Education Instructor, and researcher who has assisted thousands of clients over a more than two-decade career. She is the CEO of Xaris Financial Enterprises and a course facilitator for Cornell University.

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Private equity (PE) refers to capital investment made into companies that are not publicly traded. Most PE firms are open to accredited investors or those who are deemed high-net-worth, and successful PE managers can earn millions of dollars a year. 2 3 Leveraged buyouts (LBOs) and venture capital (VC) investments are two key PE investment sub-fields.

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How to Become a Private Equity Associate

What Is the Structure of a Private Equity Fund?

How to Make Big Money in the Finance Industry

Why Do Public Companies Go Private?

Venture capital is money, technical, or managerial expertise provided by investors to startup firms with long-term growth potential.

Private equity is an alternative investment class that invests in or acquires private companies that are not listed on a public stock exchange.

Equity typically refers to shareholders' equity, which represents the residual value to shareholders after debts and liabilities have been settled.

Series A financing is a reference to the first round of financing undertaken for a new business venture after seed capital.

A venture capitalist (VC) is an investor who provides capital to firms with high growth potential in exchange for an equity stake.

Investing is allocating resources, usually money, with the expectation of earning an income or profit. Learn how to get started investing with our guide.

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You've probably heard of the term private equity (PE). Roughly $3.9 trillion in assets were held by private equity (PE) firms as of 2019, and that was up 12.2 percent from the year before. 1

Investors seek out private equity (PE) funds to earn returns that are better than what can be achieved in public equity markets . But there may be a few things you don't understand about the industry. Read on to find out more about private equity (PE), including how it creates value and some of its key strategies.

Private equity (PE) is ownership or interest in an entity that is not publicly listed or traded. A source of investment capital , private equity (PE) comes from high-net-worth individuals (HNWI) and firms that purchase stakes in private companies or acquire control of public companies with plans to take them private and delist them from stock exchanges.

The private equity (PE) industry is comprised of institutional investors such as pension funds, and large private equity (PE) firms funded by accredited investors . Because private equity (PE) entails direct investment—often to gain influence or control over a company's operations—a significant capital outlay is required, which is why funds with deep pockets dominate the industry.

The minimum amount of capital required for accredited investors can vary depending on the firm and fund. Some funds have a $250,000 minimum entry requirement, while others can require millions more.

The underlying motivation for such commitments is the pursuit of achieving a positive return on investment (ROI). Partners at private equity (PE) firms raise funds and manage these monies to yield favorable returns for shareholders, typically with an investment horizon of between four and seven years.

The private equity (PE) business attracts the best and brightest in corporate America, including top performers from Fortune 500 companies and elite management consulting firms. Law firms can also be recruiting grounds for private equity (PE) hires, as accounting and legal skills are necessary to complete deals and transactions are highly sought after.

The fee structure for private equity (PE) firms varies but typically consists of a management and performance fee. A yearly management fee of 2% of assets and 20% of gross profits upon sale of the company is common, though incentive structures can differ considerably. 4

Given that a private-equity (PE) firm with $1 billion of assets under management (AUM) might have no more than two dozen investment professionals, and that 20% of gross profits can generate tens of millions of dollars in fees, it is easy to see why the industry attracts top talent.

At the middle market level—$50 million to $500 million in deal value—associates can earn low six figures in salary and bonuses, while vice presidents can earn approximately half a million dollars. Principals, on the other hand, can earn more than $1 million in (realized and unrealized) compensation per year. 2

Private equity (PE) firms have a range of investment preferences. Some are strict financiers or passive investors wholly dependent on management to grow the company and generate returns. Because sellers typically see this as a commoditized approach, other private equity (PE) firms consider themselves active investors. That is, they provide operational support to management to help build and grow a better company.

Active private equity (PE) firms may have an extensive contact list and C-level relationships, such as CEOs and CFOs within a given industry, which can help increase revenue. They might also be experts in realizing operational efficiencies and synergies . If an investor can bring in something special to a deal that will enhance the company's value over time, they are more likely to be viewed favorably by sellers.

Investment banks compete with private equity (PE) firms, also known as private equity funds , to buy good companies and to finance nascent ones. Unsurprisingly, the largest investment-banking entities such as Goldman Sachs ( GS ), JPMorgan Chase ( JPM ), and Citigroup ( C ) often facilitate the largest deals.

In the case of private equity (PE) firms, the funds they offer are only accessible to accredited investors and may only allow a limited number of investors, while the fund's founders will usually take a rather large stake in the firm as well.

That said, some of the largest and most prestigious private equity (PE) funds trade their shares publicly. For instance, the Blackstone Group ( BX ), which has been involved in the buyouts of companies such as Hilton Hotels and MagicLab, trades on the New York Stock Exchange (NYSE) . 5 6

Private-equity (PE) firms perform two critical functions:

Deal origination involves creating, maintaining, and developing relationships with mergers and acquisitions (M&A) intermediaries, investment banks, and similar transaction professionals to secure both high-quantity and high-quality deal flow : prospective acquisition candidates referred to private equity (PE) professionals for investment review. Some firms hire internal staff to proactively identify and reach out to company owners to generate transaction leads. In a competitive M&A landscape, sourcing proprietary deals can help ensure that funds raised are successfully deployed and invested.

Additionally, internal sourcing efforts can reduce transaction-related costs by cutting out the investment banking middleman's fees. When financial services professionals represent the seller, they usually run a full auction process that can diminish the buyer's chances of successfully acquiring a particular company. As such, deal origination professionals attempt to establish a strong rapport with transaction professionals to get an early introduction to a deal.

It is important to note that investment banks often raise their own funds, and therefore may not only be a deal referral, but also a competing bidder . In other words, some investment banks compete with private equity (PE) firms in buying up good companies.

Transaction execution involves assessing management, the industry, historical financials and forecasts, and conducting valuation analyses . After the investment committee signs off to pursue a target acquisition candidate, the deal professionals submit an offer to the seller.

If both parties decide to move forward, the deal professionals work with various transaction advisors, including investment bankers, accountants, lawyers, and consultants, to execute the due diligence phase. Due diligence includes validating management's stated operational and financial figures. This part of the process is critical, as consultants can uncover deal-killers, such as significant and previously undisclosed liabilities and risks.

There are plenty of private equity (PE) investment strategies. Two of the most common are leveraged buyouts (LBOs) and venture capital (VC) inves
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