Glossary · Funds and derivatives
Private equity
Private equity firms buy whole companies with investors’ money and a lot of borrowed money, try to make them more profitable, and sell them a few years later.
Also called: PE, buyout fund, leveraged buyout, LBO
In plain words
Imagine buying a run-down café, fixing the menu, cutting waste and selling it five years later for much more. Private equity does that with whole companies. A private equity firm raises a fund from pension funds, endowments and rich families, buys companies outright, runs them for some years, and then sells them to another buyer or lists them on the stock exchange in an IPO.
The typical deal is a leveraged buyout: the fund pays part of the price with its own money and borrows the rest. The loan is put on the bought company itself, which then has to pay it off from its profits.
The managers are paid like hedge fund managers: a yearly fee of about 1.5–2% of the money and around 20% of the profits (called carried interest).
Example
Why the borrowing matters
A fund buys a company for $100 million: $40 million of its own money and a $60 million loan. Over five years the company’s profits pay the loan down to $30 million.
- Sold for $150 million: the fund gets $150M − $30M = $120 million, three times its $40 million.
- Sold for $100 million, the same price it paid: $100M − $30M = $70 million, still a gain of 75%, all from repaying the loan.
- Sold for $50 million: $50M − $30M = $20 million, half its money lost.
Leverage and repaying the loan turn a 50% rise in the company’s value into a 200% gain; a 50% fall still costs half the fund’s money (before interest and fees).
One level deeper
A private equity fund usually lives about ten years: it invests the money in the first few, then sells the companies and returns the cash. Investors cannot take their money out early, which is why the fund is “private”: its holdings are not traded on an exchange and are valued by the managers themselves.
Supporters say private owners fix companies faster than scattered shareholders can. Critics point to the heavy debts: some bought companies were loaded with loans, paid big dividends to their owners and later went bankrupt. Both kinds of story are real; results vary a lot from fund to fund.
Venture capital is the branch of private equity that buys small stakes in young startups instead of whole mature companies.
Why it matters
Private equity owns thousands of companies you meet every day, from restaurants and retailers to software firms and hospitals, without their shares being on any stock exchange.
Pension funds put a growing share of retirement money into it, hoping for higher returns in exchange for locking it up for years.
Its heavy use of borrowing makes it sensitive to interest rates: deals are easier when money is cheap.
A common mistake
Myth: Private equity just means any company that is not on the stock market.
In fact: A private company is any company without listed shares, like most family businesses. Private equity is the investment business that buys companies, usually with borrowed money, to sell them later.
Questions people ask
What is the difference between private equity and venture capital?
Private equity mostly buys control of mature, profitable companies, often with loans. Venture capital buys minority stakes in young startups, with no loans, hoping a few of them grow enormously.
How do private equity firms make money?
From a yearly management fee on the fund (about 1.5–2%) and a share of the profits, the carried interest (about 20%), usually paid once the investors have got back their money plus an agreed minimum return.
Can ordinary people invest in private equity?
Mostly indirectly, through pension funds. Some listed private equity firms and listed funds can be bought on the stock exchange, and new funds for wealthier individuals are appearing, often with high fees and limits on withdrawals.
Read more on BigCapital
About the numbers
- This page explains a term. It is not investment advice.