What is Private Equity

June 8, 2010

What is Private Equity

Definition Answering: What is Private Equity? 

Private equity is a well-known industry in the financial world and it is becoming a more familiar term for the general public as high-profile companies are purchased and taken private by buyout firms like Chrysler, Toys R Us, and Hilton Hotels.  But there are still people who frequently ask me, “What is private equity?”  So the following is a brief answer to this question.  To learn more about the private equity industry consider joining the Certified Private Equity Professional program.  This 100% online program provides participants with a strong education in private equity that prepares professionals to work in private equity or alongside private equity firms.  Click here to learn more.

A lot of the confusion in defining private equity is that it encompasses several niche industries.  There is important distinctions between buyouts, venture capital, angel investing, mezzanine financing and distressed investments.  But all these industries often get lumped together as private equity.  So, to simplify things, when I am talking about private equity I am mostly talking about buyout firms.  So, what is a buyout firm?  What does it do?

A private equity firm launches private equity funds which are large pools of private capital used to invest in companies.  These funds are managed by private equity general partners, principals, associates, analysts, in-house or third party marketers–positions depend on the size of the firm.  Fund marketers work to reach a capital goal for a fund from capital sources, such as institutional investors (pension funds, endowment funds, etc.) or high-net-worth individuals.

In a typical buyout: The private equity fund seeks out opportunities to invest its capital.  When the management team discovers a possible opportunity it will conduct due diligence and valuation on the firm to decide how much it should offer and what the potential return on the investment would be.  Then the firm will buyout shares of the company–often using leverage as well as the private capital from the fund–to takeover a controlling interest in the company.

Buyout firms invest long term, as opposed to hedge funds or other investment funds, and will work to improve the company and generate profit through cost-cutting, selling assets and motivating management (who now have more control of the company, answering to the PE management, not ordinary shareholders).  It will usually install an advisory board to guide the company; this board is drawn from the buyout firm’s associates, general and limited partners and others.  Management will receive the kind of support and control necessary to make concrete changes to the company but, if the management is the problem, the buyout firm may install new leadership in the company.

After the private equity firm has expanded or improved the company it will look toward an exit–maybe through an IPO where shares are offered again to the public, or a strategic buyer– or decide to invest more money in the company.  The exit is how the private equity firm makes its money back on its initial investment to give returns to investors.  The hope is that the company can be sold for a significant profit.

I hope this answered the question “What is private equity?”

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Tags: What is Private Equity, private equity, buyout firms, what is a buyout firm, what is private equity, what is a private equity firm, what is private equity management, private equity investments

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