Whether or not you realize it, many of the goods, services and products you use on a regular basis are from private equity-backed companies. From picking up a box of doughnuts at Krispy Kreme
to grabbing dog food at PetSmart
and securing your home with a system like Vivint
, private equity is all around us—all the time. Picking up Arby’s
or Panera Bread
on the way home? PE-backed. Looking into your family history with Ancestry
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 blog post breaks down the basics of PE.
What is private equity?
Private equity (PE) is a major subset of a larger, more complex piece of the financial landscape known as the private markets. 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.
What do private equity firms do?
PE firms invest in businesses with a goal of increasing their value over time before eventually selling the company at a profit. Similar to venture capital (VC) 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.
Investors working at a private equity firm are called private equity investors, and as of 2017, there were 3,953 active PE investors, which is a 51% increase since 2007.
Examples of private equity firms
The Blackstone Group
Headquartered in New York, the investment firm invests in PE, real estate and more. Service King
and Change Healthcare
are portfolio companies under Blackstone.
See our The Blackstone Group profile preview.
TPG is a global firm based in San Francisco. Some of its current portfolio companies are Greencross
, Reading International
and Wind River Systems
See our TPG Capital profile preview.
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
and Vault Health
are among its current portfolio companies.
See our The Carlyle Group profile preview.
HarbourVest Partners is a PE firm headquartered in Boston. Its current roster of portfolio companies include Flash Networks
See our HarbourVest Partners profile preview.
How does private equity work?
To invest in a company, private equity investors raise pools of capital from limited partners to form a fund—also known as a private equity 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 potentially distressed, but still shows signs for growth potential. Although the structure of investments can vary, the most common deal type is a leveraged buyout or LBO.
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.
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 the limited partners that invested in its fund. Some private equity-backed companies may also go public.
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
- 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%.
- 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.