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What is Private Equity? Understanding Private Equity (PE)

Private Equity (PE) is another source of investment capital that invests in the equity capital of privately held companies, I.e. companies that are not publically traded.  PE actually derives from high net worth individuals and institutional investors that acquire equity shares of privately held companies or acquire a controlling stake in publically traded companies to make them private, eventually becoming delisted from public stock exchanges. These companies are not listed or traded on any stock exchanges. The PE capital can be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company’s balance sheet. Now private equity has gained a great amount of influence in today’s financial marketplace.

Private equity investors generally work towards funding new technology, making new acquisitions, expanding working capital and bolstering the balance sheets of companies. PE firms also work in the same manner as Venture Capitalists — invest in the long term in startups to help them grow and then reap benefits after the companies go public or merge with other firms. Unlike mutual funds or hedge funds, however, private equity firms often focus on long-term investment opportunities in assets that take time to sell with an investment time horizon typically of 10 or more years.

What is a private equity firm?

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

Who can invest in Private Equity?

A private equity fund is typically open only to accredited investors and qualified clients. Accredited investors and qualified clients include institutional investors, such as insurance companies, university endowments and pension funds, and high income and net worth individuals. The initial investment amount for a private equity investment is often very high.

Even if you are not invested in private equity funds directly, you may be indirectly invested in a private equity fund if you participate in a pension plan or own an insurance policy, for example. Pension plans and insurance companies may invest some portion of their large portfolios in private equity funds.

How Private Equity works

Private equity raises funds from institutional investors and wealthy individuals to invest in various assets. Once they’ve hit their fundraising goal, they close the fund and invest that capital into promising companies. PEs invest in stressed assets, and in leveraged buyouts of companies with the intention of solidifying their balance sheet or taking it to IPO. PEs also invest in REITs, real estate funding, and venture capital funds. The given below chart gives a fair idea about how PE works.


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.


A typical investment strategy undertaken by private equity funds is to take a controlling interest in an operating company or business—the portfolio company—and engage actively in the management and direction of the company or business in order to increase its value.  Other private equity funds may specialize in making minority investments in fast-growing companies or startups. The following are the private equity strategies that PE investors generally adopt.

a) Private Equity growth capital

b) Venture Capital

c) Leveraged Buyouts (LBOs)

d) Mezzanine Equity financing

e) Private Equity Real Estate (PERE)

f) Distressed and Special Situation

g) Fund of funds

How do Private Equity firms make money?

Private equity firms have access to multiple streams of revenue, many of those unique only to their industry. Private equity investors select settled businesses, then restructure the organization and refurbish the company to earn more money and sell it at a profit. There are really only three ways that firms make money: management fees, carried interest and dividend recapitalizations.

a) Management fees traditionally consist of a firm charging an LP 2% of committed capital. The fee is charged regardless of whether a firm is successful in generating a profit for investors. A $1 billion fund charging a 2% fee would land a private equity firm $20 million a year in revenue.

Management fees are the most consistent and reliable revenue stream because they are paid annually and are easy to predict.

b) Carried Interest, also known as “carry,” is the share of the profit earned by a private equity
fund or fund manager on the exit of investment done by the fund. It is the most important of total remuneration earned by the Fund manager.

It can be on a deal basis earned on every deal or a whole fund basis. Generally, the split in profits among the limited partners, the investors, and the general fund manager partner are 80:20. Carried Interest in private equity is not earned automatically. It will be earned by a fund manager only when a fund’s profits exceed a specified return. This specified return is known as the Hurdle rate. If the fund manager cannot achieve the hurdle rate, it won’t be entitled to receive any carried interest.

c) Dividend Recapitalization occurs when a private equity firm takes on new debt in a portfolio company to raise money to distribute a special dividend to investors who helped fund the initial purchase of the portfolio company. This allows the private equity firm to quickly recoup much of its equity investment plus profit without selling its ownership interest in the company. Dividend recaps are legal as long as the company is still solvent after paying the dividend.

What is the difference between private equity and venture capital?

Private Equity Vs Ventur Capital

Venture Capital (VC) refers to an investment made into start-ups or early-stage companies. Investors making such investments are called venture capitalists and are generally large institutions. VC firms provide funding to small companies or start-ups, which are starting to get a clear idea of their revenue stream and customers. Venture capitalists usually pool money in a VC fund and then go about investing in prospective companies and call them their portfolio companies. The investment is expected to give returns in multiples and has less risk attached compared to seed funding.

Private equity firms focus on more established businesses that need the restructuring of management and additional capital, so they can earn more profit after selling them. Because of this, private equity is considered less risky than venture capital. Private equity investors select settled businesses, then restructure the organization and refurbish the company to earn more money and sell it at a profit.

Difference Between Private Equity and Hedge Funds

Private Equity Vs Hedge Funds

Hedge funds are alternative investments that use pooled money and a variety of tactics to earn returns for their investors. Private equity funds invest directly in companies, by either purchasing private firms or buying a controlling interest in publicly traded companies. Private equity funds invest in companies that can provide higher profits over a more extended period. In contrast, hedge funds are used to invest in assets that yield good ROI or return on investment over a shorter period.

Difference Between Private Equity and Mutual Fund

Private Equity Vs Mutual Fund

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, discussed in more depth below.

Benefits (Advantages) of Private Equity

Private equity offers several advantages to companies and startups.

1. PE is an effective form of alternative capital. PE groups have deep pockets and can provide the financial resources to fuel growth. 

2. PEs are favoured by companies because it allows them access to liquidity as an alternative to conventional financial mechanisms, such as high-interest bank loans.

3. Private equity can provide the required talent with your business is lacking. These are typically hands-on groups that will help you meet new business goals and maximize company value.

4. Certain forms of private equity, such as venture capital, also finance ideas and early-stage companies/startups.

5. In the case of companies that are delisted, private equity financing can help such firms attempt unusual growth strategies away from the eyes of markets, as these companies don’t have the constant pressure of publishing their quarterly earnings.

What are some of the leading Private Equity firms?

1. The Blackstone Group Inc

Founded in 1985 and headquartered in New York, with offices in London, Hong Kong, Beijing, and Dubai, The Blackstone Group invests across a broad range of market sectors, including energy, retail, and technology. 

2. KKR & Co. Inc.

Founded in 1976 and headquartered in New York, KKR is known for being one of the first firms to engage in large-scale leveraged buyouts, which are still one of the firm’s specialities.

3. TPG Capital

TPG Inc., previously known as Texas Pacific Group, is an American investment company. The private equity firm is focused on leveraged buyouts and growth capital. TPG manages investment funds in growth capital, venture capital, public equity, and debt investments.

4. CVC Capital Partners

CVC Capital Partners is a Luxembourg-based private equity and investment advisory firm operating across American, European and Asian private equity, secondaries and credit funds. CVC’s private equity network comprises 25 offices globally, making it one of the most geographically diverse and longest-established networks of any private equity investor worldwide.

5. The Carlyle Group

The Carlyle Group is an American multinational private equity, alternative asset management and financial services corporation. It specializes in private equity, real assets, and private credit.

6. HarbourVest Partners

HarbourVest Partners is a private equity fund of funds and one of the largest private equity investment managers globally. The firm invests in all types of private equity funds, including venture capital and leveraged buyout funds, and also directly in operating companies.

7. Thoma Bravo

Thoma Bravo, LP, is an American private equity and growth capital firm with offices in San Francisco, Chicago and Miami. With more than 40 years of experience in providing capital and strategic support to experienced management teams and growing software and technology companies. Some of the most notable companies in its portfolio include McAfee, Conga, and Anchorage.

8. EQT

EQT is a purpose-driven global investment organization with close to three decades of consistent investment performance across multiple geographies, sectors, and strategies.

9. Vista Equity Partners

Vista Equity Partners is an American investment firm focused on financing and forwarding software, data and technology-enabled startup businesses. Vista has invested in hundreds of companies, including Misys, Ping Identity, and Marketo.

10. Warburg Pincus LLC

Warburg Pincus is a private partnership focused solely on private equity. The firm has over 55 years of experience in growth investing and building world-class businesses around the globe. Warburg Pincus applies a thesis-driven approach to investing across a variety of sectors and geographies. The firm has developed domain expertise in Consumer, Energy, Financial Services, Healthcare, Industrial & Business Services, Real Estate, and Technology.


The above article gives a better understanding of private equity basics and how it works. You can find detailed information about the topics relating to private equity from the below links or by searching our website. Do let us know your feedback and thank you for reading the article.

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About the author

Dileep K Nair

Mr Dileep is currently the managing partner of Unifinn Capital Global and an advisor to the investment banking and corporate finance world. He is a mentor, entrepreneur, business advisor and investment banking expert with an overall 19 years of experience in investment banking, retail banking and corporate finance and business management. He handled a wide range of corporate finance transactions, including private equity funding, private debt, venture capital, angel investing, M&A, LBO etc worldwide.




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