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What is Private Equity?  

By Sunita Arnold, Mar 18, 2024

Businessperson presenting a money bag in front of a lineup of wooden figures, symbolizing investment in private equity

Private equity (PE) refers to a form of investment where capital, which is not listed on a public exchange, is invested directly into private companies. It’s a financial frontier for those who seek to own stakes in entities away from the glare of public markets. At its most fundamental level, private equity is about direct investment in companies, distinguishing it from public equity where investments are made in companies listed on stock exchanges. The firms involved in private equity investments are typically structured as partnerships that manage funds on behalf of investors looking to diversify their holdings beyond traditional stocks and bonds. 

Understanding the Players 

The PE ecosystem comprises several key players. First, there are the investors or limited partners (LPs) that provide the capital. These LPs are often institutions like pension funds, insurance companies, endowments, or wealthy individuals seeking to allocate a portion of their portfolio to higher-risk, higher-return investments. 

The second group is the general partners (GPs), who run the PE firm. They are the strategists and the managers who identify potential companies to invest in, conduct the rigorous due diligence required, and then oversee these companies’ post-investment to drive growth and profitability. 

The Investment Approach 

Private equity firms aim to create value in a range of ways. Typically, they look for companies with growth potential or those that are undervalued or in need of strategic direction, operational improvements, or financial restructuring. Once a target company is acquired, the private equity firm may provide additional capital investments, strategic guidance, and operational support to promote growth and profitability with the aim of selling the company later at a significant profit. 

PE firms often employ what is known as a ‘buy and build’ strategy. This involves purchasing a platform company and then acquiring additional smaller companies in the same industry to create synergies and drive value. This strategy can help transform modest enterprises into industry powerhouses. 

Duration and Returns 

Private equity investments are generally long-term in nature, with firms holding onto an investment for several years. The lifespan of a PE investment typically ranges from four to seven years, during which the firm’s experts work closely with the company to achieve growth objectives before seeking an exit. 

The expected returns from private equity are typically higher than those from traditional equity markets due to the increased risks associated with investing in non-public entities. This potential for higher returns, coupled with the benefits of diversification, is what attracts investors to this asset class. 

The Impact of Private Equity 

The allure of private equity lies in its dual potential: the ability to revitalize underperforming companies and to provide the necessary capital and strategic support to growing businesses. It can bring about transformations that not only yield financial returns but also contribute to economic growth and job creation. These transformative impacts underscore the essential role that private equity plays in the broader investment landscape. 

How Private Equity Works 

Understanding how private equity operates can provide investors with insights into why it can be such a powerful investment tool. In this section, we delve into the mechanics of PE investments, from fundraising to exit strategies, painting a picture of the private equity lifecycle and its multifaceted nature. 

Fundraising and Fund Structure 

The journey of a private equity firm typically starts with fundraising, where capital is raised from limited partners. These investors commit funds to the PE firm’s investment vehicle, commonly structured as a limited partnership or a limited liability company. The PE firm, acting as the general partner, is responsible for managing the fund’s operations and investment decisions. 

These investment vehicles are usually closed-end funds with a fixed investment period – often 10 years, with the possibility of extensions. During this period, the PE firm will identify opportunities, deploy capital into investments, manage the portfolio companies, and then, ultimately, exit these investments with the aim of returning a profit to the LPs. 

Investment Selection and Value Addition 

Once the capital is in place, the private equity firm begins the process of selecting investments. This entails rigorous market research, detailed financial analysis, and thorough due diligence. PE firms seek out companies with strong growth potential or those that are undervalued and ripe for operational improvements or market expansion. 

After acquiring a company, the PE firm works to add value in various ways. This may involve streamlining operations, enhancing management teams, expanding into new markets, or driving organic growth and efficiency. It’s a hands-on approach, leveraging the expertise of the PE firm’s professionals to unlock value that prior owners or management may have missed. 

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Management of Portfolio Companies 

Active management is a hallmark of private equity. Unlike passive investments in public markets, PE firms engage deeply with their portfolio companies. They may appoint members to the board of directors, work closely with existing management, or bring in external executives to drive the business forward. The objective is clear: to bolster the company’s performance and position it for a profitable exit. 

The Exit Strategy 

An exit is the final, and often most crucial, phase in the private equity investment cycle. It’s when the PE firm seeks to sell its stake in a portfolio company to realize the gains from the value that’s been added. There are several exit routes that a PE firm may take: 

  • Initial Public Offering (IPO): A company is taken public, and shares are sold on a stock exchange. 
  • Strategic Sale: The business is sold to a larger company, often in the same industry. 
  • Secondary Sale: The stake is sold to another private equity firm. 
  • Management Buyout (MBO): The company’s management team buys the PE firm’s stake, often with financial backing from other investors. 

The choice of exit strategy depends on market conditions, the company’s readiness for public markets, and the strategic fit with potential buyers. 

Distribution of Returns 

Once an exit is completed, the PE firm distributes the returns from the sale to the limited partners, according to their share of the investment in the fund. After accounting for the PE firm’s management fees and performance fees, known as carried interest, investors can often expect higher returns than those typically generated in public markets, reflecting the higher risk and longer investment horizon associated with private equity. 

Through this cycle, private equity offers a disciplined yet flexible approach to investing that can generate substantial rewards for those who understand its nuances. Each stage of the private equity process is critical to the overall success of the investment, and it’s the careful management of each phase that sets apart the most successful PE firms. 

Risk and Reward Dynamics 

The private equity space is characterized by its high-risk, high-reward nature. Investors understand that not every investment will bear fruit, but the successes are expected to compensate for any failures. The PE firm’s skill in selecting and managing investments is critical to delivering strong returns to its investors. 

The Role of Private Equity in the Economy 

Private equity is often portrayed as a financier of the high-stakes world of corporate buyouts and business building, but its impact goes far beyond the boardroom. PE has become a powerful engine of economic growth, with a role that is multifaceted and far-reaching. 

Catalyst for Growth and Innovation 

PE firms are known for investing in companies with growth potential, providing not just capital but strategic support. This infusion often enables companies to innovate, grow, and become market leaders. For instance, a PE firm might invest in a company that has an innovative product but lacks the necessary infrastructure to market or distribute it effectively. With PE backing, the company can scale up operations, enhance its offering, and even expand internationally. 

Job Creation 

Contrary to the image of PE firms as ‘corporate raiders’ interested solely in cutting costs, many PE investments lead to job creation. By turning companies around and setting them on a growth trajectory, these firms can create new opportunities for employment. For instance, a company may be capable of developing new products or expanding to new markets after a PE firm’s investment, thereby requiring more manpower and creating new jobs. 

Operational Efficiency 

Private equity investors typically take an active role in the management of the companies they invest in, striving to increase value by improving operational efficiency. They may streamline operations, cut redundant processes, or introduce new technologies that make production more cost-effective. This drive for efficiency often results in better service for customers and more resilient companies. 

Stimulating Competition 

PE firms can enhance market competition by backing smaller players that challenge established ones. Increased competition can lead to better services and products, lower prices for consumers, and overall market health. Companies that may not have had a chance to compete due to lack of resources can become significant players with the help of PE. 

Revitalizing Struggling Sectors 

Often, PE firms target companies in industries that are struggling or undergoing transformation. With their capital and expertise, they can turn these companies around, leading to a revitalization of entire sectors. For example, a traditional manufacturing sector plagued by outdated technology and processes can be transformed with PE intervention, adopting innovative technology and practices that revamp the sector’s global competitiveness. 

Promoting Entrepreneurship 

PE also plays a vital role in the entrepreneurial ecosystem. Venture capital, a subset of PE, is especially crucial in seeding funding for startups. PE investment in these young companies enables them to grow and become the innovation leaders of tomorrow. Through this, PE firms contribute to a dynamic entrepreneurial culture, which is a cornerstone of a healthy economy. 

Navigating Economic Cycles 

Private equity investment can act as a stabilizing force within the economy. During downturns, PE firms often have the capital and the appetite to invest when other sources of business financing may dry up. This counter-cyclical investing can help keep companies afloat during tough times and position them for growth when the economy recovers. 

Private Equity Strategies 

Private equity firms employ a variety of strategies to achieve their investment goals, which not only helps companies grow but also generates returns for their investors. Here are some of the common strategies used: 

  • Leveraged Buyouts (LBOs): This is one of the most well-known strategies where a PE firm acquires a controlling interest in a company using a significant amount of borrowed money. The acquired company’s cash flows are used to pay back the debt over time, and ideally, the firm is sold later for a profit. 
  • Growth Capital: Companies often need capital to expand without giving up control. PE provides this growth capital, taking a minority stake and offering strategic advice to help the company scale up operations, enter new markets, or finance significant projects. 
  • Venture Capital: As a subset of PE, venture capital is focused on early-stage companies with high growth potential. Venture capitalists provide funding in exchange for equity, and their returns are realized if the company goes public or is acquired. 
  • Distressed Funding: Some PE firms specialize in investing in distressed companies, providing the capital and expertise needed to restructure and turn around their fortunes. These investments can be risky but also offer substantial returns if the turnaround is successful. 
  • Real Estate Private Equity: This strategy involves investing in various types of real estate properties and projects, ranging from commercial real estate to housing developments. The focus is on enhancing the value of properties through strategic upgrades and effective management. 

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Measuring Private Equity Performance 

Evaluating the performance of private equity investments is crucial for investors. Performance is typically measured using the following metrics: 

  • Internal Rate of Return (IRR): The IRR is a common metric that calculates the annualized effective compounded return rate of the PE investment, taking into account the time value of money. 
  • Multiple on Invested Capital (MOIC): This metric shows how many times the investment has been returned. A MOIC of 2x means the investor has doubled their money. 
  • Distribution to Paid-In (DPI): DPI measures the cumulative distributions received from the investments relative to the total amount of capital contributed. 
  • Total Value to Paid-In (TVPI): TVPI combines DPI and the residual value of the investment to give a total picture of value relative to the paid-in capital. 

Risks and Considerations in Private Equity 

Investing in private equity comes with its own set of risks and considerations: 

  • Illiquidity: Private equity investments typically have a long-time horizon, and investors should be prepared to have their capital locked in for periods of five years or more. 
  • Limited Transparency: Compared to public markets, private markets may offer less transparency, making it more challenging to assess investment opportunities. 
  • Market Risk: Like any investment, PE is subject to market risks, including economic downturns that can affect the performance of portfolio companies. 
  • Management Risk: The success of a PE investment often hinges on the performance of the management team, which can vary greatly. 

The Future of Private Equity 

The future of private equity looks bright, with trends pointing toward continued growth and innovation: 

Democratization of Access: Platforms like Linqto are making investing more accessible to a broader range of investors, allowing more individuals to participate in the private markets

Technological Advancements: Technology is playing a larger role in PE with the advent of data analytics and artificial intelligence, which can improve deal sourcing, due diligence, and portfolio management. 

ESG Considerations: There’s a growing focus on environmental, social, and governance (ESG) factors in PE investment decisions, reflecting broader concerns about sustainability and corporate responsibility. 

Increasing Globalization: PE firms are looking beyond their home markets more than ever, seeking opportunities in emerging markets and diversifying their investment portfolios globally. 

Private Equity vs. Public Equity 

When investors consider diversifying their portfolio, they often weigh the options between private equity (PE) and public equity markets. These two spheres of investment present unique characteristics and opportunities. 

Volatility: Public equity markets are known for their liquidity and volatility. Stocks can be bought and sold with the click of a button, and prices change constantly based on real-time information, market sentiment, and broader economic indicators. Private equity investments, however, are not subject to the same daily price fluctuations since they are not traded on an open market. This can result in a lower correlation with public markets and potentially provide a buffer during times of market stress. 

Regulatory Oversight: Public companies are subject to stringent regulatory requirements. They must provide regular financial disclosures and are closely monitored by entities like the Securities and Exchange Commission (SEC) in the United States. Private companies, by contrast, operate under less stringent disclosure requirements, offering a different kind of investment transparency. This can lead to more latitude in operations and, potentially, quicker adaptations to market changes or strategic pivots. 

Investment Timeframe: Investments in public equities can be made with various time horizons in mind but generally offer more flexibility for investors who may wish to exit their positions. Private equity investments are typically long-term, with investors committing their capital for several years. This long-term horizon aligns with the PE firm’s strategy to grow and improve the company’s value before an eventual exit. 

How to Get Involved in Private Equity 

Engaging with private equity once required significant capital and insider access, often limiting participation to institutional or high-net-worth accredited investors. However, the landscape is shifting, and access is broadening. 

Direct Investments: Traditionally, direct investments are a straightforward path into PE for those with the requisite capital. Investors commit a substantial sum directly into a private equity fund or co-invest with a PE firm in a specific deal. Such direct investments provide a clear and focused PE exposure but require significant due diligence and a high degree of investor sophistication. 

Crowdfunding Platforms: Technological advancements and regulatory changes have paved the way for crowdfunding platforms, which lower the entry barriers to private equity. These platforms allow individual investors to commit smaller amounts of capital to private or early-stage companies, democratizing access to this investment class. 

Fund of Funds: A ‘fund of funds’ (FoF) offers individual investors exposure to a portfolio of private equity funds. This diversification can mitigate risk, as investors are not tied to the fortunes of a single company or deal. An FoF also offers professional management, with experienced fund managers making complex decisions about which PE funds to include. 

Democratizing the Next Frontier of Investing 

Integrating into the evolving PE landscape requires not just capital but also expertise and market insight. Secondary market platforms have emerged, offering investors a more accessible path to private equity. These platforms aim to curate private company opportunities and provide transparency and ease of transaction for investors accustomed to the liquidity of public markets. 

Effective secondary platforms maintain a balance between offering exclusive investment opportunities and adhering to the regulatory framework designed to protect investors. This ensures that while investors are venturing into complex and potentially lucrative investment territories, they are doing so within a structured and regulated environment. 

As private equity continues to evolve, these secondary platforms are indicative of the broader trend of democratization within the space. They stand as a bridge between the traditional, exclusive world of PE investing and the more accessible future, providing compliant and curated pathways for qualified investors looking to diversify their portfolios with private equity’s unique potential for growth. 

This material, provided by Linqto, is for informational purposes only and is not intended as investment advice or any form of professional guidance. Before making any investment decision, especially in the dynamic field of private markets, it is recommended that you seek advice from professional advisors. The information contained herein does not imply endorsement of any third parties or investment opportunities mentioned. Our market views and investment insights are subject to change and may not always reflect the most current developments. No assumption should be made regarding the profitability of any securities, sectors, or markets discussed. Past performance is not indicative of future results, and investing in private markets involves unique risks, including the potential for loss. Historical and hypothetical performance figures are provided to illustrate possible market behaviors and should not be relied upon as predictions of future performance.


Sunita Arnold

Sunita Arnold

As Director of Content Strategy at Linqto, Sunita deftly merges creative and strategic planning. Guiding a talented team, she aligns content with marketing objectives to deliver compelling, brand-consistent materials. Her diverse 15+ year career spans fintech, healthcare, and public relations, with highlights including managing investor relations for an alternate investment platform, steering business development in a leading PR firm's sports and entertainment sectors, and overseeing operations for a wealth management data service. Her past achievements include significantly contributing to the growth and efficiency of a top global fund administrator. Keeping pace with industry trends, Sunita applies her strategic acumen and market insight to advance Linqto's content strategy.