What Is Private Equity?

When I worked in investment banking I once was asked if I was a teller.  A few years later while working in private equity strangers at parties would ask me for stock tips.  If I took away anything from the decade plus of learning the art of deal making is that private equity is not well understood.  We put together this handy guide so you can better explain to love ones and new friends what it is you actually do.

To help provide some context as to why understanding private equity is important take a look at these stats. Pitchbook data, suggests that private equity firms invested upwards of $3.4 trillion of capital in leveraged buyouts from 2000 – 2012.[1]  It is estimated that one of ten companies are owned by private equity and those firms employ more than 7.5 million people[2]

Now that the reach of private equity is a little clearer, let us dive into the nuts and bolts of private equity.

The Basics

1.       Private equity in the broadest sense is exactly what it says…any type of equity investment in a private business.

2.       More commonly when people refer to private equity, they are referring to institutional private equity.  These are investment firms that raise funds (not unlike mutual funds in certain ways, but for private companies) that invest equity capital in private businesses.

3.       Institutional PE funds are really a way to classify and describe a common legal fund structure and its corresponding fee structure.

4.       Private equity encompasses a number of strategies across various size businesses at various stages of growth, development, and health.  People often use private equity and various sub-types of private equity (e.g., venture capital and buyouts) loosely, inconsistently, and interchangeably.

What is Institutional Private Equity? 

What most people refer to when they talk about private equity is really institutional private equity.  This may also be referred to as “committed PE funds” or just “committed funds” for short.  Institutional private equity funds are generally characterized by the following:

1.       Fund structure (GP / LP structure)

2.       Committed capital / dedicated fund(s)

3.       Contractual investment period / fixed fund life

4.       “2 & 20” fee structure

How Does It All Work?

Thanks for asking because we spent some time building this graphic for you.


Are All Private Equity Groups The Same?

Private equity exists on a continuum.  The graphic below highlights the types of private equity. It is important to note that some private equity groups move up and down this spectrum typically by operating multiple investment funds focused around each spectrum.  Some private equity groups specialize beyond the size or investment type by choosing to invest only in a specific industry vertical.  For simplicity sake, we will focus our attention to the stage continuum.

There are a couple of conventions regarding industry jargon that are worth mentioning. 

  • Private equity is sometimes used to refer more to the right side of the stage continuum, namely recapitalizations and buyouts. 
  •  Private equity is sometimes used synonymously with the phrase leveraged buyout or LBO to the exclusion of other types of PE.  Some people contend that widespread use of the term private equity was effectively a rebranding of the phrase leveraged buyout, which had become tarnished and associated with such practices as hostile takeovers and the junk bond implosion…basically the 1980s “money culture” written about extensively by Michael Lewis and others and epitomized by Gordon Gekko’s “greed is good” mantra.  There is historical merit to this rebranding assertion. 
  •  Sometimes private equity firms are referred to as “financial sponsors.”  Often times lenders will be more aggressive with leverage and other terms with a PE firm sponsoring the transaction than if a private company attempted a similar transaction on its own—but that is an entirely other topic.
  •  Venture capital is a type of private equity much the same way a square is a type of rectangle (but not the other way around).  If venture capital is being referenced, it is most commonly mentioned by name rather than more broadly as private equity.
  • Some people will throw mezzanine financing (“mezz” or “mezz debt”) in the stage continuum; however, in the context of private equity (emphasis on the equity) that is not appropriate because mezz financing is most commonly a form of debt financing.  Mezzanine financing (also known as subordinated debt) is a common type of debt used to finance a portion of leveraged buyout transactions.

It is really that simple.  Keep coming back to Deal Sherpa Press and we will simplify other parts of the deal making process, along with educate you on some core finance concepts.

To train the best deal attorneys, bankers, consultants, and aspiring students, Private Equity Primer created industry-leading training that leverages repetition to mastery, case study delivery, and real world simulations.  Please check outour full service offerings and subscribe to our email list for the latest on training, transaction knowledge, and the ever changing landscape of legal services, investment banking, and accounting. 

[1] Source: Private Equity at Work: When Wall Street Manages Main Street by Eileen Appelbaum & Rosemary Batt, pages 35 - 37 (further cited source is Pitchbook).  This only includes leveraged buyouts and excludes all non-control private equity transactions.  It is also hard to imagine that this picks up all transactions as many are undisclosed.  It does, however, pick up secondary buyouts (where a company is sold from one PE firm to another PE firm), which accounted for about one-third of the transactions by transaction count.

[2] A PEGCC 2009 study estimated the total employment of private equity backed companies in the U.S. being between 7.5 million and 8 million (www.pegcc.org/wordpress/wp-content/uploads/Growth-Fact-Sheet.pdf, www.pegcc.org/education/pe-by-the-numbers/).  The U.S. Bureau of Labor Statistics listed seasonally adjusted private sector jobs at 118,402,000 as of December 2014 (www.bls.gov/news.release/empsit.t17.htm).  7.5 million divided by the 118.4 million jobs yields about 6.33%.  If one were to cross reference this analysis by firm size, the influence would be even more pronounced.