Private equity firms are companies that invest in private businesses by acquiring full or partial ownership through a variety of investment strategies. They play an important role in providing capital and operational expertise to companies across industries and investment types.
In this comprehensive guide, we will cover everything you need to know about private equity firms including:
What is Private Equity?
Private equity refers to equity capital that is not listed on a public exchange It is an alternative investment class that involves acquiring ownership stakes in companies that are not publicly traded on stock exchanges The capital typically comes from institutional investors and high net worth individuals,
Some key features of private equity include:
- Private Ownership – The companies invested in are privately held, not publicly traded
- Active Management – PE firms take an active role in managing and advising portfolio companies
- Illiquidity – Investors commit capital for longer investment horizons, typically 5-7 years
- Potential for High Returns – Returns can potentially be higher compared to public market investments
By providing capital and expertise, private equity firms aim to increase the value of their investments over time for eventual profitable exits.
Types of Private Equity Firms
There are several types of private equity firms that target different segments
- Venture Capital – Invest in early stage, high growth startups and technology companies
- Growth Equity – Invest in more mature, profitable companies looking to expand
- Buyout – Acquire controlling stakes in established companies via leveraged buyouts
- Distressed PE – Invest in troubled or bankrupt companies
- Mezzanine – Provide subordinated debt financing for leveraged buyouts
The most common strategies are venture capital and leveraged buyouts Each type plays a different role across the business growth lifecycle,
Key Players in the Industry
Some of the major players in the private equity industry include:
- Blackstone
- KKR
- Carlyle Group
- Apollo Global Management
- TPG Capital
- Warburg Pincus
The industry is dominated by large global private equity firms with billions in assets under management. Many top firms are also publicly traded, allowing retail investors exposure to private equity returns.
What Do Private Equity Firms Do?
Private equity firms engage in three main activities:
Raise Capital – PE firms raise funds from institutional investors, high net worth individuals, and sovereign wealth funds. This capital is then used to invest in and acquire companies.
Source Deals – They identify investment opportunities, conduct due diligence, and negotiate acquisitions. Extensive networks and relationships are leveraged to source the best deals.
Manage Portfolio – After acquiring a company, PE firms work closely with management to improve operations, cut costs, expand revenues, and position it for exit.
A key way PE firms drive returns is by improving the operational and financial performance of portfolio companies. Their access to capital and deep expertise across industries allow them to create value in target companies.
Private Equity Investment Strategies
While PE firms target a range of companies across sectors, some common investment strategies include:
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Leveraged Buyouts (LBOs) – This involves acquiring a controlling stake in a company using a significant amount of borrowed money. The debt is repaid using the cash flows of the acquired company.
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Growth Equity – Investing in relatively mature companies in need of capital to expand or restructure operations.Takes minority stakes.
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Venture Capital – Taking an ownership stake in early stage startups with potential for high growth. The investments provide capital and guidance.
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Distressed PE – Investing in troubled companies by purchasing the debt and influencing a restructuring. Also invest directly in bankruptcies.
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Mezzanine Financing – Providing subordinated debt or preferred equity to facilitate leveraged buyouts for acquisitions.
Each strategy serves a unique purpose in generating returns from private companies across the business lifecycle.
Exit Strategies for Private Equity Firms
After improving the value of a portfolio company, PE firms seek exits to realize returns. Some common exit strategies include:
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IPO – Taking the company public through an initial public offering.
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Secondary Sale – Selling the company to another private equity firm.
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Sale to a Strategic Buyer – Selling to another company in the same industry.
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Recapitalization – Taking on new debt to pay back equity investors.
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Management Buyout – Selling the company to existing management.
Well-timed exits are key to earning substantial returns on PE investments. Firms aim to exit at 3-7 years when the portfolio company valuation is maximized.
Pros and Cons of Private Equity Firms
Pros
- Generate strong returns by improving operations
- Provide capital to grow companies
- Operational expertise to create efficiencies
- Align management incentives
Cons
- Use high amounts of debt in buyouts
- Short-term focus to maximize exits
- Potential for large layoffs and cost-cutting
- Lack of transparency as private companies
PE firms provide valuable capital and expertise for growth, but certain strategies have drawn criticism around their financial engineering and aggressive cost-cutting.
Private Equity Compensation and Career Path
Working at a private equity firm is extremely lucrative but challenging to break into. Positions include:
- Associate – Entry-level role involved in analyzing deals and due diligence. Base salary ~$150K.
- Vice President – Oversees execution and management of portfolio company investments. Base ~$250K.
- Principal – Senior investment professional who leads deals. Base ~$500K.
- Partner – Highest role responsible for raising capital and investment decisions. Base ~$1M + carry.
Bonuses and carried interest can substantially increase total compensation, especially for Partners. The career path usually starts in investment banking or consulting.
How to Invest in Private Equity
While direct private equity investing requires millions in capital, there are some options for retail investors:
- Publicly traded private equity firms like Blackstone, KKR, and Apollo
- Mutual funds focused on private equity
- Private equity ETFs
- Equity crowdfunding platforms
- Managed private equity access funds
These provide various levels of exposure to private equity returns for non-accredited investors.
The Future of Private Equity
The private equity industry will continue evolving:
- Continued growth in assets under management
- More competition and pressure on returns
- Rise of mega-funds above $10B+ in size
- Expansion to new sectors and geographies
- Increased regulatory scrutiny and oversight
- More institutionalization and transparency
Private equity will remain an important source of capital and driver of innovation for private companies globally.
Private equity firms provide capital, expertise, and strategic guidance to acquire and improve private companies across industries. Though certain strategies like leveraged buyouts have drawbacks, PE continues to offer an attractive alternative investment class for institutional and high net worth investors. Understanding the multiples players, investment strategies, and operations of private equity firms provides helpful context into this influential component of global finance and business.
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Why Private Equity Draws Criticism
Private equity firms have pushed back against the stereotype depicting them as strip miners of corporate assets, stressing their management expertise and examples of successful transformations of portfolio companies.
Many are touting their commitment to environmental, social, and governance (ESG) standards directing companies to mind the interests of stakeholders other than their owners.
Still, rapid changes that often follow a private equity buyout can often be difficult for a companys employees and the communities where it has operations.
Another frequent focus of controversy is the carried interest provision allowing private equity managers to be taxed at the lower capital gains tax rate on the bulk of their compensation. Legislative attempts to tax that compensation as income have met with repeated defeat, notably when this change was dropped from the Inflation Reduction Act of 2022.
How Are Private Equity Funds Managed?
A private equity fund is managed by a general partner (GP), typically the private equity firm that established the fund. The GP makes all of the funds management decisions. It also contributes 1% to 3% of the funds capital to ensure it has skin in the game. In return, the GP earns a management fee often set at 2% of fund assets, and may be entitled to 20% of fund profits above a preset minimum as incentive compensation, known in private equity jargon as carried interest. Limited partners are clients of the private equity firm that invest in its fund; they have limited liability.
What REALLY is Private Equity? What do Private Equity Firms ACTUALLY do?
Where does private equity come from?
A source of investment capital, private equity comes from firms that buy stakes in private companies or take control of public companies with plans to take them private and delist them from stock exchanges. Private equity can also come from high-net-worth individuals eager to see outsized returns.
What does a private equity firm do?
Private equity firms raise client capital to launch private equity funds, and operate them as general partners, managing fund investments in exchange for fees and a share of profits above a preset minimum known as the hurdle rate.
What is a private equity investment?
Private equity (PE) refers to capital investments made in companies that are not publicly traded. Most PE firms are open to accredited investors or high-net-worth individuals, and successful PE managers can earn over a million dollars a year. Leveraged buyouts (LBOs) and venture capital (VC) investments are two key PE investment subfields.
What is a private equity firm (PE)?
* AUM data sourced from company websites, current as of March 2023. What Is a Private Equity Firm? Private equity firms, commonly called PE firms, pool investor funds to invest in or acquire companies that are not publicly traded on a stock exchange.
