What is Private Equity and how does it work?

Welcome to our guide to Private Equity 101.

What is Private Equity? How does it work? Is it a good career choice for me? If you are one of the many people looking to learn about this rewarding and rapidly growing industry then you have arrived at the right place.

There is enormous interest in Private Equity, which is only set to increase as the market continues to grow. It was worth $4.74 trillion globally back in 2021, with Deloitte forecasting it to hit $5.8 trillion by 2025.

Private Equity is a hugely important industry, it’s one of the main pillars of the global economy.

So, whether you are interested in exploring the possibility of a future career in PE or simply curious about how it all works, then you have arrived at the right place.

Carnegie Consulting has been at the forefront of PE recruitment since our inception back in 2006, so it’s fair to say that we know a thing to two about how it all works!

With that in mind, we have put this guide together to answer some of the questions we get asked every day.

Let’s get started.

Sections/Chapters:

What is Private Equity?

Private Equity (PE) is an industry made up of investment funds, managed by Private Equity specialists (management companies). The management company oversees a fund raising process, targeting a variety of investors, then manages the deployment of that capital into illiquid assets.

The buyside investment industry can be separated into public and private investment firms, with asset managers and hedge funds on the public (liquid) side and private equity firms on the private (illiquid) side, investing into unlisted securities.

Occasionally, Private Equity firms will look to acquire a publicly listed business. This is known as a ‘take private’ transaction and involves the business being delisted from the relevant exchange.

Whilst ‘buyout’ (majority investments) is the better known private equity strategy, there are many other strategies, targeting businesses at all stages of development and in a wide range of circumstances.

What is a Private Equity Firm?

A Private Equity Firm is a company that identifies and executes investments, acquiring either a minority or majority stake in an unlisted business, with the intention of achieving a profitable exit in the future. They may also acquire a publicly listed business, delisting the company in a take private transaction.

Once they identify a target and perform detailed due diligence, the transaction goes to the investment committee, consisting of any number of senior figures within the company. If approved then they will attempt to execute on the investment.

They look for companies with untapped potential and identify ways to increase their value through a combination of corporate restructuring, cost saving and growth/innovation.

When a PE firm identifies a suitable target they make a detailed assessment of that company, identifying anything pertaining to that company that may be a factor in their equations. They rigorously assess current and potential future profitability, always assessing ways to increase the latter.

This means looking at the potential target company’s recent financial performance, its market presence, its management and wider staffing structures, possible running cost savings, potential areas of growth and increased profit.

PE firms don’t typically get involved with the day to day running of the company. They leave this to the company’s staff while they concentrate on the bigger strategic picture of improving operations and increasing profitability.

What is a Private Equity Fund?

A Private Equity (PE) Fund is a collective investment scheme managed by a PE firm, also known as the General Partner (GP), on behalf of investors (Limited Partners) in exchange for fees and a share of profits.

It is a pool of capital, invested on a discretionary basis by the PE firm. Having a sizeable amount of committed capital allows them to pursue long term strategies with the goal of achieving superior returns.

A PE Fund is typically a Limited Partnership with a fixed term of 5 – 10 years. Such funds carry substantial entry requirements for investors and typically require a minimum commitment which, once invested, can be locked-up for in excess of 10 years.

Investment control is often highly limited. The PE Firm, or GP, usually retains full management rights throughout the term of the investment.

PE funds are considered risky investments. However, they also offer incredible ROI potential and a large number of funds enjoy a remarkable level of success.

What is a Private Equity Investor?

Private Equity investors are typically institutional investors, such as pension funds and insurance companies, sovereign wealth funds and local government bodies. However private wealth offices and high net worth individuals may also be investors, depending on the minimum commitment.

They are seeking high returns and are able and willing to tie up large sums of capital in an illiquid asset for a long time in order to achieve this.

What are the different strategies of Private Equity?

As the PE industry has matured, many firms have begun to specialise in certain business areas or strategies.

Sector specialisms have become more common, with some Private Equity firms focussing solely on tech or energy for example. Geography is also a significant factor with sub-sections of the industry focusing on Emerging Markets or specific geographical regions.

A companies investment strategy is hugely important as it defines the parameters that they raise capital against, and therefore how they are able to deploy that capital.

Whilst buyouts and majority investments remain the staple of Private Equity deals, secondary buyouts have also become commonplace as a result of specialisation. Secondary buyouts are when one Private Equity firm sells a company to another. For example, a PE firm will execute its specialist strategy – such as cost cutting – before selling it on to another firm that specialises in developing new revenue streams.

Other specialist business areas include carve outs: buying subsidiaries or units of other companies; and distressed investing, such as taking on struggling businesses where turnaround and restructuring opportunities exist.

Minority investing, also known as growth, is a rapidly growing strategy due to the ability to start with a smaller initial fund size, lowering barriers of entry to new PE firms.

Minority investments are typically more passive, looking for companies with solid balance sheets and strong management teams, where the capital injection or expertise provided by the PE firm can help move the target company forwards.

An ever expanding are of the market is debt funds. Private Equity firms who specialise in providing financing for deals, liquidity solutions or who specialise in managing non-performing debt instruments.

The growth of the secondaries market has been a huge boost to the overall industry. Secondaries firms will buyout the fund positions of investors who need to liquidate their stake. The emergence of viable liquidity solutions has reduced the risk to investors, bringing more capital into the industry.

Venture capital is also as a sub-set of private equity, focussing on start-ups and early stage businesses.

How is a Private Equity Firm structured?

PE Firms come in a wide range of sizes, specialities and cultures. However, a typical PE Firm structure will look something like this:

How is the Private Equity industry regulated?

In the United Kingdom, Private Equity firms are regulated by the Financial Conduct Authority (FCA).

Additionally, UK PE firms can follow a voluntary self-regulatory regime called the Guidelines for Disclosure and Transparency in Private Equity, supported by Private Equity Reporting Group (PERG). This provides the industry with a set of rules and established oversight.

In the US, Private Equity is regulated by the U.S. Securities and Exchange Commission (SEC) under the Investment Company Act of 1940 or the Securities Act of 1933.