Private Equity
What is Private Equity?
Private equity is investment in companies whose shares are not publicly traded, usually by funds that buy control of a business and sell it years later.
Private equity funds raise capital from institutions and wealthy investors, then buy mature companies outright, either firms that were always private or public firms taken off the exchange. Most buyouts are paid for partly with the fund's own capital and largely with money borrowed against the acquired company, which magnifies both the gain and the loss on the equity that was put in. The fund holds for several years, replaces or pushes management, cuts costs or expands the business, then exits by selling to another buyer or listing the shares. Because the stakes are not traded, investors cannot cash out on demand and their money is committed for years. The contrast with venture capital is control and maturity: venture funds take small stakes in unproven startups, private equity funds take charge of established, cash-generating firms.
Private Equity: a worked example
A fund buys a company for $500 million, putting in $150 million of its investors' money and borrowing the other $350 million against the company itself. Over five years the company's cash flow repays $100 million of that debt, leaving $250 million owed, and the fund then sells the business for $600 million. After the debt is settled, $600 million minus $250 million leaves $350 million on the $150 million invested. Run it the other way: a sale at $300 million would leave only $50 million, a third of what went in. Borrowed money works in both directions.
The mistake students make with private equity
Private equity and venture capital get used as if they were the same business. Venture funds buy small stakes in young companies that usually lose money, while private equity funds buy control of established firms and pay for much of the purchase with debt. A second mistake is assuming you can buy into private equity the way you buy a stock. The stakes are not listed, minimum commitments are large, and money is locked up for years.
Private Equity questions
What is the difference between private equity and venture capital?
Private equity funds buy control of mature, cash-generating companies, often financing much of the purchase with debt, while venture capital funds buy minority stakes in young companies that have no profits yet. The risk profiles follow from that: venture funds expect many outright failures, whereas buyout funds depend on steady cash flow to service borrowings. Both are private, long-term and illiquid.
What is a buyout?
A buyout is the purchase of a controlling interest in a company, usually financed with a mix of the buyer's own capital and debt secured against the company being bought. A management buyout is the version in which the firm's own executives are the purchasers. Taking a listed company private through a buyout removes its shares from the exchange.
Can ordinary investors put money into private equity?
Direct private equity funds are generally restricted to institutions and to individuals who meet regulatory wealth or income tests, and their minimum commitments run far above what a small investor would put in. Indirect exposure exists, for instance through publicly listed firms that manage private equity funds. The exact rules differ by country.
Related terms
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