Private equity (PE) refers to investments made directly into private companies—or public companies that are later taken private—using funds raised from institutional investors or high-net-worth individuals. The primary goal is to improve the company’s value over time and eventually exit through a sale or IPO, generating substantial returns.
Private equity plays a significant role in corporate finance, mergers and acquisitions, and long-term investment strategies. It influences everything from business growth to turnaround plans and ownership transitions.
This article covers how private equity works, who participates, how deals are structured, and what it means for businesses and investors.
What Is Private Equity?
Private equity is a form of capital investment that involves buying equity stakes in companies that are not listed on public stock exchanges. These investments are typically illiquid, long-term, and actively managed by the private equity firm or fund.
The companies invested in are usually:
- Privately held firms seeking growth capital
- Public companies targeted for buyouts and privatization
- Underperforming businesses with turnaround potential
- Family-owned companies looking for succession solutions
How Private Equity Firms Operate
Private equity firms raise capital through limited partnerships (LPs), where the firm acts as the general partner (GP) and the investors are the limited partners. The GP is responsible for sourcing deals, managing investments, and generating returns, while LPs contribute capital with limited liability.
The typical private equity lifecycle includes:
- Fundraising: Capital is raised from LPs such as pension funds, insurance companies, family offices, and sovereign wealth funds.
- Deal Sourcing: The firm identifies target companies with growth or restructuring potential.
- Due Diligence and Investment: After extensive analysis, the firm makes an equity investment, often gaining control of the business.
- Value Creation: The firm works with management to improve operations, increase efficiency, and drive growth.
- Exit: After several years (typically 3 to 7), the firm exits the investment via a sale, IPO, or recapitalization.
Common Types of Private Equity Deals
1. Leveraged Buyout (LBO)
A PE firm acquires a company using a mix of debt and equity. The acquired company’s cash flow is used to repay the debt over time. LBOs are common in mature businesses with stable revenue.
2. Growth Equity
Capital is invested in high-growth private companies to accelerate expansion. These deals usually involve minority stakes without taking full control.
3. Distressed Investments
Capital is injected into financially troubled or undervalued companies, often with a plan to restructure and revive operations.
4. Venture Capital (Early-Stage PE)
Although technically a subset of private equity, venture capital focuses on startups and early-stage businesses with high growth potential.
5. Secondary Buyouts
One PE firm sells a portfolio company to another PE firm, often as part of a later-stage optimization or exit strategy.
Key Players in Private Equity
- Private Equity Firms: General partners managing capital and driving portfolio performance.
- Limited Partners: Institutional investors providing capital with expectations of outsized returns.
- Portfolio Companies: The businesses that receive investment and undergo strategic transformation.
- Investment Bankers and Advisors: Support transaction structuring, due diligence, and exit planning.
- Management Teams: Often retained post-investment to execute the growth or restructuring plan.
Private Equity Fund Structure
Private equity funds are usually closed-end vehicles with a fixed life span, often around 10 years. The typical fund structure includes:
- Investment period: First 3 to 5 years, during which capital is deployed.
- Harvest period: Final 5 to 7 years, where value is realized through exits.
- Carried interest: A performance fee (typically 20%) the GP earns on profits above a hurdle rate.
- Management fees: Annual fees (usually around 2%) paid to the GP for fund administration.
This structure aligns incentives between fund managers and investors.
Benefits of Private Equity
1. Access to Capital
Companies gain funding for growth, restructuring, or acquisitions without relying on public markets.
2. Operational Improvement
Private equity investors often bring expertise, resources, and strategic discipline to portfolio companies.
3. Long-Term Focus
Without the pressure of quarterly earnings, private equity-backed businesses can take bold, long-term actions.
4. Strong Returns
When executed well, private equity investments can generate returns that outperform public markets.
Risks and Challenges
Private equity is not without risk. Key considerations include:
- Illiquidity: Investors typically commit capital for 7–10 years with limited ability to withdraw.
- Leverage Risk: LBOs depend heavily on debt; poor performance can lead to default.
- Market Timing: Exiting investments during a downturn can limit returns.
- High Fees: Management and performance fees can eat into net returns if not properly managed.
- Control Dynamics: Founders and management teams may have to give up control to investors.
Private equity is best suited for investors with long time horizons and a tolerance for complexity.
Private Equity vs. Public Equity
| Feature | Private Equity | Public Equity |
| Ownership | Privately held businesses | Publicly traded companies |
| Liquidity | Illiquid, long holding periods | Highly liquid, tradeable on exchanges |
| Control | Often includes control of portfolio company | Minority interest, limited influence |
| Reporting | Less frequent, less transparent | Regulated, regular reporting |
| Return Strategy | Operational improvement and sale | Stock appreciation and dividends |
While both are equity investments, private equity involves deeper operational involvement and higher return potential, offset by higher risk and lower liquidity.
How Businesses Can Prepare for Private Equity Investment
For founders and business owners, private equity can be a strategic partner—not just a funding source. To attract private equity investment:
- Demonstrate stable cash flow
- Show operational upside or scalability
- Have clear governance structures in place
- Be open to active involvement from investors
- Prepare clean financials and long-term forecasts
Companies considering PE should weigh the trade-offs between capital, control, and the pressure to deliver strong exit outcomes.
Private equity is a powerful force in the financial world, offering businesses access to strategic capital and investors access to high-growth potential. From buyouts to growth equity, it plays a key role in scaling companies, driving transformation, and creating value across sectors.
For investors, private equity offers attractive returns, diversification, and access to companies not available in public markets. For business owners, it offers capital and expertise, though it requires readiness to collaborate and share control.
Considering a strategic investment, planning an exit, or preparing for growth? Durity helps founders, CFOs, and finance teams model, negotiate, and manage private equity partnerships with precision and clarity.
