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Private Equity

What is private equity and how does it work?

Private equity (PE) is a form of financing where capital is invested into a private company, typically a mature business, in exchange for majority stake.

Whether you realize it or not, many of the goods, services, and products you use every day are from private equity-backed companies. Grabbing dog food at PetSmart? It’s private equity-backed. Picking up Arby’s or Panera Bread on the way home? Yep, those are PE-backed, too. Looking into your family history with Ancestry? PE is all around us all the time.

But what exactly is private equity? A foundational concept for anyone interested in learning about—or working in an industry tangential to—the private markets, this article breaks down the basics of PE.

What is private equity?

Private equity (PE) is a form of financing where money, or capital, is invested into a company. Typically, PE investments are made into mature businesses in traditional industries in exchange for equity, or ownership stake. PE is a major subset of a larger, more complex piece of the financial landscape known as the private markets.

PE is an alternative asset class alongside real estate, venture capital, distressed securities, and more. Alternative asset classes are considered less traditional equity investments, which means they are not as easily accessed as stocks and bonds in the public markets. We dedicated an entire article outlining the difference between the public and private sectors.

How does private equity work?

To invest in a company, private equity investors raise pools of capital from limited partners (LPs) to form a fund. Once they’ve hit their fundraising goal, they close the fund and invest that capital into promising companies. PE investors may invest in a company that’s stagnant or distressed, but still shows signs for growth potential.

When a PE firm sells one of its portfolio companies to another company or investor, the firm usually makes a profit and distributes returns to LPs that invested in its fund. Some PE-backed companies may also go public.

What are the 3 main strategies for PE investments?

We’ve outlined the three main strategies for PE investments below. It’s important to note that many private equity investors are adapting their tried-and-true investment strategies at present given current market uncertainties.

  • Buyout: A buyout is when an investor purchases a majority stake in a company. The most common deal type is a leveraged buyout (LBO). In fact, LBOs accounted for 66% of all PE deals in 2021, and the median deal size for LBOs in 2021 was $101 million. In a leveraged buyout, an investor purchases a controlling stake in a company using a combination of equity and a significant amount of debt, which must eventually be repaid by the company. In the interim, the investor works to improve profitability, so that the debt repayment is less of a financial burden for the company.

  • Growth: Sometimes, instead of purchasing a majority stake in a company, an investor will acquire a minority stake, looking to further grow the company. This type of investment is similar to VC investments in that no debt is used and only a minority stake is given in exchange for capital. These investments typically take place at the intersection of VC and PE, where companies are still growing but may have already proven some profitability. Growth financing accounted for 11% of all PE deals in 2021, and the median deal size was $30 million.

  • Mezzanine: Mezzanine is a unique strategy within PE—it bridges the gap between debt and equity. When a company receives mezzanine financing from a private equity group, it takes on debt (capital with the agreement to pay it back, plus interest) that includes some “embedded equity.” Essentially, that means that the debt can be converted into equity. Sometimes warrants are attached, which allow the lender to purchase equity at a set price at a later date while keeping the original debt. Sometimes mezzanine debt is taken on by itself, and other times, it is in conjunction with another transaction—mostly LBOs.


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What is a private equity firm?

A private equity firm is a type of investment firm. They invest in businesses with a goal of increasing their value over time before eventually selling the company at a profit. Similar to venture capital firms, PE firms use capital raised from limited partners (LPs) to invest in promising private companies.

Unlike VC firms, PE firms often take a majority stake—50% ownership or more—when they invest in companies. Private equity firms usually have majority ownership of multiple companies at once. A firm’s array of companies is called its portfolio, and the businesses themselves, portfolio companies.

How do private equity firms make money?

PE funds collect both management and performance fees. These can vary from fund to fund, but the typical fee structure follows the 2-and-20 rule.

What are management fees?

Calculated as a percentage of assets under management or AUM, typically around 2%. These fees are intended to cover daily expenses and overhead and are incurred regularly.

What are performance fees?

Calculated as a percentage of the profits from investing, typically around 20%. These fees are intended to incentivize greater returns and are paid out to employees to reward their success.

What are some examples of private equity firms?

The Blackstone Group

Headquartered in New York, The Blackstone Group is an investment firm that invests in PE, real estate and more. Service King, Optiv, and Change Healthcare are portfolio companies under Blackstone.

TPG Capital

TPG Capital is a global firm based in San Francisco. Some of its current portfolio companies are Greencross, Reading International, and Wind River Systems.

The Carlyle Group

Headquartered in Washington, DC, The Carlyle Group is a PE firm and business development company that focuses on a wide range of sectors. Memsource, X-Chem, and Vault Health are among its current portfolio companies.

HarbourVest Partners

HarbourVest Partners is a PE firm headquartered in Boston. Its current roster of portfolio companies include Flash Networks, Fundbox, and Rodenstock.

What is a private equity investor?

Investors working at a private equity firm are called private equity investors.They are critical to raising capital as well as identifying companies that will make good investment opportunities. PitchBook tracks global investors, including more than 15,000 whose primary investor type is private equity as of December 2022.

What is a private equity fund?

A PE fund is a pool of capital raised by PE investors and sourced from LPs.

PE funds vs. hedge funds

Both private equity funds and hedge funds are restricted to accredited investors. However, the biggest differences between PE funds and hedge funds are fund structure and investment targets. Hedge funds tend to operate in the public markets, investing in publicly-traded companies while PE funds focus on private companies.

PE funds vs. mutual funds

The biggest differences between PE funds and mutual funds are where capital comes from, the types of companies the fund invests in and how the firm collects fees. PE funds raise capital from LPs, which are accredited, institutional investors and mutual funds leverage capital from everyday investors. PE funds typically invest in private companies whereas mutual funds typically invest in publicly-traded companies. And mutual funds are only allowed to collect management fees, whereas PE funds can collect performance fees.

What’s the difference between private equity and venture capital?

Private equity refers to investments or ownership in private companies. It’s also used as a term for the PE strategy of investing. Venture capital investments are a form of PE investment that tend to focus more on early-stage startups. So, VC is a form of private equity. Here are some additional distinctions between PE and VC.

Unique characteristics of private equity

  • PE firms often invest in mature businesses in traditional industries.
  • Using capital committed from LPs, PE investors invest in promising companies—typically taking a majority stake (>50%).
  • When a PE firm sells one of its portfolio companies to another company or investor, returns are distributed to the PE investors and to the LPs. Investors typically receive 20% of the returns, while LPs get 80%.

Unique characteristics of venture capital

  • VC firms often invest in tech-focused startups and other young companies in their seed.
  • Using committed capital, VC investors usually take a minority stake (<50%) in the companies they invest in.
  • Most of these companies are not fully established or profitable, so they can be risky investments—but with that risk comes the opportunity for big returns.
  • The firm makes a profit if a company they’ve invested in goes public or gets acquired, or by selling some of its shares to another investor on the secondary market.

Interested in learning more about the private markets?
Download our guide to understanding this fast-growing economic sector.

Private Market Guide