Private Equity 101: Everything You Need to Know

What is Private Equity?

Private equity (PE) is a form of investment that involves buying shares in private companies or taking public companies private to improve their value before eventually selling them.

Unlike public stock investments, PE typically focuses on high-growth potential, restructuring, or operational improvement in companies that are not listed on stock exchanges. Private equity firms raise large pools of capital from institutional investors and high-net-worth individuals to invest in businesses with the goal of generating substantial returns.

How do Private Equity Firms Operate?

Private equity firms operate by raising capital from institutional investors—such as pension funds, endowments, and high-net-worth individuals—and pooling it into funds dedicated to specific investment strategies. These firms then use that capital to acquire stakes in private companies or take public companies private. Private equity firms often aim to enhance the value of these companies through strategic changes, improved management, and operational efficiencies before selling their stakes at a profit. The process from investment to exit typically spans several years, allowing the firm enough time to improve the company’s performance and increase its value.

Within a private equity firm, the roles of general and limited partners are key to understanding the structure. General partners (GPs) are responsible for managing the fund and making investment decisions, while limited partners (LPs) are the investors who contribute capital but have limited involvement in day-to-day operations. GPs usually earn management fees and a percentage of the profits, known as carried interest, if the investments perform well. This structure aligns incentives for general partners to maximize returns, benefiting both themselves and the limited partners.

Three Pillars of Private Equity

PE generally falls into 3 different categories of investing: venture capital, growth equity, and buyouts. Each contains different strategy's, risks, and time horizons.

Venture Capital

Venture capital focuses mainly on investing in newly founded companies who are still at their early stages known as start-ups. Venture capital firms provide the capital necessary for these companies to grow in exchange for an equity stake (part ownership of the company).

This form of investment is a high-risk high-reward investment as many startups generally fail at their early stages, however the reward for it succeeding is substantial, as seen with the firm Sequoia Capital and its early investment in Google. Venture capital is also a very active form of investment where investors commonly provide suggestions on what they believe would be the best decision for the company to take.

Growth Equity

Growth equity investments targets larger more mature companies who are looking to expand but haven’t considered an initial public offering (IPO). These companies usually already have experienced a lot of success and a good amount of revenue stream, proving to have a strong business model overall.

Investors help these companies with financing initiatives, expanding them into new markets such as capital expenditures (purchasing of physical assets such as property, equipment, industrial buildings, etc) or executing acquisition (purchasing a majority or complete stake of another company).

A very notorious example of this form of investment is Silver lake’s partnership with Alibaba in 2011, where Silver Lake, a private equity firm specializing at technological sectors, made an investment that provided Alibaba with the necessary capital it needed to enhance in areas such as infrastructure and develop an individual mobile payment platform, Alipay. When Alibaba went public in 2014, it created history with the largest IPO ever with around $25 billion raised at the New York stock exchange.

Leveraged Buyouts (LBOs)

Finally, the last major private equity category are buyout investments. This is a common form of investment in private equity that focuses on acquiring majority of stake of an established company, allowing investors to control it with the aim of restructuring it to improve profitability.

In buyouts, PE firms utilize leverage (debt) to finance their acquisitions, which is typically why this form of transaction is known as leverage buyouts. After acquiring a company, firms typically implement cost cutting measures and other operational improvements to enhance the companies value before exiting the company by either selling it or with an IPO.

One of the most memorable examples of this form of investment is Blackstones acquisition of Hilton Hotels which generated them over 14 billion in revenue in the time span of eleven years.

Works Cited

Lynch , Peter. “Private Equity Fund Structure.” A Simple Model, 7 Feb. 2022, www.asimplemodel.com/insights/private-equity-fund-structure.

“Hilton Hotels Corporation to Be Acquired by Blackstone Investments Funds.” Blackstone, 2 Aug. 2024, www.blackstone.com/news/press/hilton-hotels-corporation-to-be-acquired-by-blackstone-investments-funds/.