Library guide · Capital Allocation
What Is Private Equity?
Investing in private companies to build their value and sell them at a profit, explained plainly.
Private equity is investing in private companies, ones not listed on a stock exchange, with the aim of improving them and selling them at a profit years later. It is run through closed-end funds that raise money from investors, buy companies, spend several years increasing their value, and return the proceeds when the companies are sold.
Private equity is one of the largest and most misunderstood corners of finance. Stripped of jargon, it is simple: buying companies that are not on the stock market, making them more valuable, and selling them for a profit.
How it works
Private equity is run through closed-end funds. A manager (the general partner) raises money from investors (limited partners), commits it over the fund's life of about ten years, and uses it to buy private companies, or to take public companies private. Often the purchase is partly funded with debt, which amplifies returns.
The manager then spends several years improving each company, growing its revenue and profit, sharpening operations, sometimes merging it with others, before selling it, to another company, another fund, or the public market. The proceeds are returned to investors, and the fund winds down.
How it makes money
Value in a private equity deal is created in three ways: growing the company's earnings, paying down the acquisition debt (which increases the equity's share of the value), and selling at a higher valuation multiple than was paid. Over long horizons, buyout funds have delivered roughly 14 to 18 percent net annual returns, meaningfully above public markets, though much of that edge is an illiquidity premium, the reward for locking capital away for a decade.
The manager is paid on the classic 2 and 20 model: a 2 percent annual management fee plus 20 percent of profits above a hurdle.
Why families invest in it
Private equity suits patient capital, which is why family offices allocate heavily to it. A family that can lock money up for ten years can capture the illiquidity premium that shorter-horizon investors cannot. Families access it three ways: as limited partners in funds; by co-investing in specific deals alongside a fund, often at reduced fees; or by investing directly in companies themselves. The larger and more sophisticated the office, the more it tilts toward the last two, to gain control and avoid paying a full layer of fees. Private equity is not a product you dip into; it is a long-term commitment that pays those who can wait.
Frequently asked questions
- What is private equity?
- Private equity is investment in private companies, businesses not traded on a public stock market. Private equity funds raise money from investors, buy companies (often using debt), work to grow their value over several years, and sell them at a profit, returning the gains to investors.
- How does private equity make money?
- By buying a company, increasing its value, and selling it for more. Value is created three ways: growing the business's earnings, paying down the debt used to buy it, and selling at a higher valuation multiple than was paid. Managers also earn fees, classically 2 percent a year plus 20 percent of the profits.
- How do family offices invest in private equity?
- Three ways: as investors (limited partners) in private equity funds; by co-investing directly in specific deals alongside a fund, often at reduced fees; or by making direct investments into companies themselves. Larger family offices increasingly do the latter two to gain control and avoid a layer of fees.
This guide is educational and general in nature. It does not constitute investment, legal, tax or financial advice.
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