In this article, we break down the basics of private equity and explain what you need to know.
Private equity definitionPrivate equity is a major subset of a much larger, complex part of the financial landscape known as the private markets. Private equity is a form of financing where capital is invested into a company, usually mature businesses in traditional industries, in exchange for equity.
What do private equity firms do?Private equity firms invest in businesses with a goal of increasing value over time before eventually selling the company at a profit. Similar to venture capital firms, PE firms use capital raised from limited partners to invest in promising private companies.
In contrast to VC firms, PE firms often take a majority stake—meaning 50 percent 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 percent increase since 2007. Examples of private equity firms include:
The Blackstone Group
Headquartered in New York, the investment firm invests in private equity, real estate and more. Service King, Optiv and Change Healthcare are portfolio companies under Blackstone.
TPG is a global private equity firm based in San Francisco. Some of its current portfolio companies are Greencross, Reading International and Wind River Systems.
How does private equity work?In order 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.
The companies PE firms want to invest in usually look different from the startups VC firms get involved with. For starters, private equity investors might invest in a company that’s stagnant, or potentially distressed, but still has growth possibilities.
Although the structure of private equity investments can vary, the most common deal type is a leveraged buyout.
In a leveraged buyout (LBO), 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 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.
Interested in learning more about the private markets? Download our guide to understanding this fast-growing economic sector.