What is Private Equity?

Private Equity is an alternative investment class composed of funds and investors that directly invest in private companies or engage in buyouts of public companies. The capital for Private Equity is provided by institutional and retail investors to fund new technology, make acquisitions, expand working capital, and to earn returns that are better than what can be achieved in public equity markets.

How Does Private Equity Work?

Private Equity funds have two types of partners, Limited Partners (LP) and General Partners (GP). Limited Partners typically own 99% of shares in a fund and have limited liability, while General Partners own 1% of shares and are entirely liable. Limited Partners are the investors that help provide capital, while General Partners are the Private Equity firms that manage and operate the investments. Private Equity firms raise money from institutional investors (such as mutual funds, pensions, and insurance companies) and accredited investors (an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities) for a variety of funds that will invest into different types of assets.

Private Equity firms will charge management fees and performance fees on managed assets. The management fee is typically 2% of the managed assets, charged annually. Additionally, the firm will require around a 20% performance fee. Fees are where Private Equity firms make a majority of their profit. For example, a $4 billion fund charging a 2% management fee means the firm will earn $80 million regardless of whether or not it is successful in generating a profit for investors.

What are the Different Types of Private Equity Funds?

Below will give a basic overview of the four main types of Private Equity funding:

1. Distressed funding — Private Equity firms look to invest in underperforming and “distressed” businesses with the intention of coming in and reviving the business by making changes to the company’s management structure, operations, or assets for a profit.
2. Leveraged Buyouts(LBO) — An LBO is the most popular form of Private Equity funding and is probably the one you have heard of before. In an LBO, the Private Equity firm will buy out a company to improve its financial performance and health, then either resell the company or conduct an IPO. The reason why it is called a “leveraged” buyout is because the firm will typically use debt to finance as much as 90% of the transaction and is transferred to the acquired company’s balance sheet for tax benefits.
3. Real Estate Private Equity — Private Equity firms will invest in commercial real estate and real estate investment trusts (REIT). A REIT is a company that owns, operates, or finances real estate and pools the capital of numerous investors to allow investors to earn dividends from the real estate investments. Investors will buy shares in commercial real estate portfolios and are generally a steady source of income.
4. Venture Capital — Venture capital investments are a popular form of Private Equity funding in which investors (also called angels) provide capital to start-up companies or entrepreneurs. This capital can be used to take an idea from a prototype to an actual product or help grow a company to compete in a market.

Breaking into Private Equity

Most professionals break into Private Equity after working 2–3 years as an analyst at an Investment Bank and are looking to transition into the buy-side. The majority of Private Equity hires are:

• Investment Banking Analysts at a bulge bracket or elite boutique bank
• Undergraduates for junior-level roles, such as Private Equity Analysts
• Professionals who worked at a different Private Equity firm

The positions at Private Equity firms are more limited than at Investment Banks and therefore very competitive. The timeline for on-cycle Private Equity recruitment begins essentially just a few months into starting as an analyst at a bulge bracket or elite boutique bank. The process is very quick, with funds interviewing and handing out offers within a matter of days. Though after receiving an offer, hires will continue to work at the bank and not start at their new position for up to two years. For many Investment Banking Analysts, the switch to Private Equity means better pay, more meaningful work, and a better work/life balance. Overall, the path to Private Equity is quite streamlined but rewarding for those who are looking for exit opportunities from Investment Banking.