Private equity firms raise money from institutional investors (e.g. pension funds, insurance companies, sovereign wealth funds and family offices) for the purpose of investing in private businesses, growing them and selling them years later, generating better returns for investors than they can reliably get from public market investments.
Private equity firms do not run the businesses they invest in. They back an experienced management team to carry out an ambitious but realistic growth plan usually over a period of three to five years. The key to success is making sure that the management team is able to focus fully on executing the growth plan. This means that the private equity investment must provide an exit for shareholders wishing to leave the business, a partial exit for those wishing to ‘de-risk’ or ‘step back’ and equity for new or existing team members that need incentivising. A private equity deal achieves this at its outset and the result is an aligned, executive management team, heavily motivated to take on an ambitious growth plan.
Following investment, private equity firms take an active but non-executive role in the business, contributing particularly where their skills as financers can help, such as finding and funding acquisitions, building the company’s finance and governance functions and assisting with the recruitment of senior hires.
How can private equity benefit me?
Private equity is used to fund positive change in a business. Owner-managers that have spent their careers painstakingly building a valuable business can realise some of that value (for cash) and approach their business thereafter in the knowledge they are no longer risking everything when they make a bold business decision.
Private equity funding is flexible, and every deal is tailored and negotiated to fit the situation. Each shareholder can have a different deal and full or partial exits can be accommodated in differing proportions for each shareholder, usually depending on the executive’s day-to-day role in the business and their role in its ongoing success. As importantly, significant equity incentives can be created to retain and reward ‘rising stars’ in the business to enable and manage succession in the senior team.
Because a private equity firm invests with a view to selling the business in the medium term, the company needs to be well-invested to be attractive to the eventual acquirer. On exit, a private-equity-backed business is usually resourced for the next phase of expansion so that it is attractive to a wide range of buyers. The following example illustrates how a private equity deal can work.
To further explore private equity as an option for your business, please get in touch with our team today.
FAQs
Private equity firms invest the money they collect on behalf of the fund's investors, usually by taking controlling stakes in companies. The private equity firm then works with company executives to make the businesses — called portfolio companies — more valuable so they can sell them later at a profit.
How does private equity make money? ›
Private equity firms invest the money they collect on behalf of the fund's investors, usually by taking controlling stakes in companies. The private equity firm then works with company executives to make the businesses — called portfolio companies — more valuable so they can sell them later at a profit.
How does private equity really work? ›
Private equity owners make money by buying companies they believe have value and can be improved. They make money by improving the company, which generates more profits, making them money. They also make money when they eventually sell the improved company for more than they bought it for.
What are the disadvantages of private equity? ›
However, it's important to keep in mind that private equity also comes with its fair share of challenges and drawbacks. The illiquidity of investments, lack of transparency in fund management and potential conflict of interest all need to be carefully considered before investing.
What is the minimum investment for private equity? ›
Minimum Investment Requirement
Private equity investing is not easily accessible for the average investor. Most private equity firms typically look for investors who are willing to commit as much as $25 million. Although some firms have dropped their minimums to $250,000, this is still out of reach for most people.
What percentage does private equity take? ›
Calculated as a percentage of the profits from investing, typically around 20%. These fees are intended to incentivize greater returns and are paid out to employees to reward their success.
Are private equity guys rich? ›
The 22 members on the latest Forbes 400 list who made their fortunes in private equity are now worth a combined $153.7 billion. Leading the list this year is Stephen Schwarzman, chairman and CEO of Blackstone Group, with a net worth of $37.4 billion.
Does private equity always buy 100%? ›
How private equity works – deal structures. The deal structure when selling to a private equity firm usually follows a common path. In most cases, the private equity firm will not buy 100% of the business, but instead will prefer to own only 70-80% of the business.
What is the 2 20 rule private equity? ›
At its most basic, the two and twenty is basically the standard fee structure for venture capital firms to charge their investors. The 2% is the annual fee that the fund charges investors to manage the fund. And the 20% is the percentage of the upside that the fund managers take.
Is it hard to get into private equity? ›
Is It Hard to Get Into Private Equity? Yes! Private equity is one of the most competitive jobs to get – period. Not just in finance, but across the board.
Private equity funds are illiquid and are risky because of their high use of debt; furthermore, once investors have turned their money over to the fund, they have no say in how it's managed. In compensation for these terms, investors should expect a high rate of return.
What are the three types of private equity funds? ›
There are three key types of private equity strategies: venture capital, growth equity, and buyouts.
Why are private equity funds risky? ›
Capital risk: The returns from private equity investments can be affected by numerous factors, including (but not limited to) the skills of the fund manager, the effectiveness of the fund's strategy, the environment for IPOs, and interest rates.
What are the three ways to make money in private equity? ›
Private equity firms have access to multiple streams of revenue, many of those unique only to their industry. There are really only three ways that firms make money: management fees, carried interest and dividend recapitalizations. Let's first take a look at how PE firms capitalize on various fees.
Do people in private equity make good money? ›
Benefits / Advantages: High salaries and bonuses at all levels, with the potential for carry to boost senior-level compensation far beyond what investment bankers earn. More interesting work than investment banking and other sell-side roles.
What does 2 and 20 mean in private equity? ›
"Two" means 2% of assets under management (AUM), and refers to the annual management fee charged by the hedge fund for managing assets. "Twenty" refers to the standard performance or incentive fee of 20% of profits made by the fund above a certain predefined benchmark.
How much do private equity owners make? ›
In the previous articles on the private equity career path and private equity salaries, we quoted a base salary + bonus range of $700K to $2 million USD for Partners. This compensation range is wide because so much depends on the fund size, your seniority, and the fund's performance.
