Private Equity

Private equity firms raise capital from institutional investors — pension funds, endowments, sovereign wealth funds, and high-net-worth individuals — and pool it into closed-end funds with defined lifespans, usually ten years with optional extensions. The fund manager, called the general partner (GP), deploys that capital by acquiring stakes in private companies with the goal of improving operations, expanding revenue, and ultimately selling the business at a higher valuation.

The most common private equity strategy is the leveraged buyout (LBO), where the GP acquires a controlling interest in a mature company using a combination of equity from the fund and significant debt placed on the target company. The debt amplifies returns if the investment succeeds, but it also increases the risk of distress if cash flows weaken. Other strategies include growth equity, where the GP takes a minority stake in a high-growth company without heavy leverage, and distressed investing, which targets companies in or near bankruptcy.

Returns in private equity are measured using the internal rate of return (IRR) and a multiple called the total value to paid-in capital (TVPI). Because the portfolio is not marked to market daily, reported performance is smoother than public market equivalents, which critics argue flatters the asset class. The proper benchmark is a public market equivalent (PME), which adjusts for the timing of cash flows.

Liquidity is the primary constraint. Investors commit capital for the fund's life and cannot redeem early without finding a secondary market buyer at a discount. The J-curve phenomenon — where early losses from fees and slow deployment temporarily depress returns before gains emerge — means investors must be patient. Private equity has historically delivered a premium over public equities, though the size of that premium after fees is debated.

In the US, private equity funds are typically structured as limited partnerships and regulated under the Investment Advisers Act. Fund managers register with the SEC once they manage above threshold asset levels.