Understanding Private Equity (PE)

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Private equity (PE) is ownership of companies that are not listed on a public stock exchange, along with the firms and funds that buy, manage and later sell those stakes. A private equity firm raises money from large investors, uses it (often together with borrowed money) to buy all or part of private companies or to take public companies private, works to make those companies more valuable, and then sells them, usually several years later. The goal is a return higher than what public markets would deliver. In exchange, investors accept long lock-ups, high fees and limited transparency.

What Private Equity Means

A company’s equity is either listed on an exchange, where anyone can buy shares, or held privately by founders, families, employees or investors. Private equity is the business of investing in that second category. The word describes where the shares sit, not secrecy or who owns the firm.

The term covers three related things:

1. The asset class. Stakes in unlisted companies, held by investors as part of a broader portfolio.
2. The firms. Investment managers such as Blackstone, KKR, Apollo Global Management and Carlyle Group that raise and run PE funds.
3. The funds. Pooled vehicles, each with a fixed life, that hold a portfolio of company investments.

When people say a company is “PE-backed,” they mean a private equity fund owns a significant or controlling stake in it. The company being bought is usually called the target company during the deal and a portfolio company after the purchase closes.

PE firms do not only buy companies that were always private. A common move is the take-private: a firm buys all the shares of a listed company, delists it, restructures it out of public view, and may later take it public again. Blackstone’s acquisition of Hilton Hotels in 2007 is a well-known example; Hilton later returned to the stock market.

The industry is large. Industry research put assets controlled by PE firms at roughly $8 trillion to $9 trillion worldwide in 2024. Deal activity runs in cycles: the total value of private deals peaked around $3 trillion in 2021 and fell afterward as borrowing became more expensive.

How a Private Equity Fund Works

The general partner (GP) is the PE firm, or an entity it controls. It finds deals, makes investment decisions, oversees portfolio companies and decides when to sell. The GP typically commits some of its own money to the fund, and the firm’s founders often hold a large stake, which ties their wealth to the fund’s results.

Limited partners (LPs) supply most of the capital. Their liability is limited to what they commit, and they have little say in individual investments. LPs include public and corporate pension funds, university endowments, foundations, insurance companies, sovereign wealth funds, family offices and high-net-worth individuals.

Several mechanics make PE different from buying a mutual fund:

• Committed capital, not upfront cash. An LP commits a dollar amount when the fund is raised. The GP then issues capital calls, drawing down that money as it finds deals, usually over the first few years.
• A fixed fund life. Funds are commonly structured to last about 10 years, with an investment period at the start and a harvesting period later, sometimes with extensions. Individual companies are typically held for four to seven years.
• Distributions as companies are sold. When the GP exits an investment, proceeds flow back to LPs. Investors get their money back unevenly, deal by deal, not on demand.
• The J-curve. Fees and deal costs come first and gains come later, so a fund’s reported returns often look negative in its early years before rising as investments mature and are sold. Plotted over time, that pattern resembles the letter J.
• Vintage year. Funds are often compared by the year they began investing, because funds that deploy money in the same economic conditions face similar prices and financing costs.

Minimum investments depend on the firm and the fund. Some funds accept $250,000; others require several million dollars or more. Because funds also limit how many investors they take, the largest checks usually come from institutions.

Who Can Invest Directly

In the U.S., private funds are generally offered only to investors who meet Securities and Exchange Commission (SEC) definitions designed for people who can absorb losses and evaluate complex, lightly regulated offerings. The main threshold is the accredited investor. An individual generally qualifies with annual income above $200,000 ($300,000 together with a spouse or partner) in each of the past two years with the expectation of the same this year, or with net worth above $1 million excluding the primary residence. Holders of certain securities licenses can also qualify. Some funds go further and accept only qualified purchasers, a higher standard tied to holding at least $5 million in investments for individuals.

The Main Private Equity Strategies

“Private equity” spans strategies that differ in risk, company maturity and how much debt is used.

Leveraged Buyouts (LBOs)

In a leveraged buyout, a PE firm buys a company, usually taking control, and finances a large part of the price with debt. That debt is secured by the target’s own assets and cash flows, and it sits on the target company’s balance sheet after the deal, not on the PE firm’s. The fund puts up the equity portion, which may be a minority of the purchase price.

Leverage magnifies results in both directions. A hypothetical example, ignoring fees, taxes, interest costs and transaction expenses, shows how:

The fund invested $200 million and received $500 million, a 2.5x multiple on its money, or roughly 20% a year over five years. Had it paid the full $500 million in cash, the same improvement would have produced $700 million, a 1.4x multiple. The debt let a smaller equity check capture the same gain in company value.

Now reverse it. If EBITDA falls to $40 million, the exit multiple drops to 8x and no debt is repaid, the company is worth $320 million. After repaying $300 million of debt, the equity is worth $20 million: the fund loses 90% of its investment. An all-equity buyer in the same situation would have lost 36%. If the company cannot cover its interest payments along the way, lenders may take control and the equity can be wiped out.

The 1989 buyout of RJR Nabisco by Kohlberg Kravis Roberts (KKR) remains the best-known symbol of the LBO era. Because borrowing costs drive these deals, the interest-rate environment shapes how expensive buyout debt is and what buyers can afford to pay.

Venture Capital (VC)

Venture capital is equity investment in young companies, often in new or fast-changing industries, that lack the revenue, cash flow or credit history to borrow or list on an exchange. The dot-com startups of the 1990s are the classic example. VC investors usually take minority stakes, expect many investments to fail, and depend on a few large successes. Beyond money, they often guide inexperienced management on hiring, strategy and later fundraising.

In VC rounds, one investor typically acts as the lead: it negotiates the valuation and terms, often commits the largest amount, and may take a board seat. Other investors follow on those terms.

Growth Equity

Growth equity sits between VC and buyouts. The targets are established, often profitable companies that need capital to expand into new markets, make acquisitions or build capacity. Investors usually take significant minority stakes and use little or no debt.

Distressed and Turnaround Investing

Some firms specialize in companies in financial trouble. They may buy a struggling business outright, buy its debt at a discount and convert it into ownership during a restructuring, or inject capital to stave off bankruptcy. Risk is high, and so is the potential payoff when a turnaround works.

Secondaries and Funds of Funds

Secondaries funds buy existing stakes in PE funds from LPs who want to exit early, or buy portfolio companies from other funds. They give investors a way out of an otherwise locked-up commitment, often at a price below the stake’s reported value. Funds of funds invest in a portfolio of other PE funds, spreading a single commitment across many managers and vintage years in exchange for an extra layer of fees. They sometimes have lower minimums than a single fund, but many are still restricted to accredited investors.

Active Versus Passive Owners

PE firms also differ in how hands-on they are. Some act as financiers and rely on existing management to grow the business. Others market themselves as active owners that bring industry contacts, relationships with CEOs and CFOs, and operational expertise. Because sellers often treat pure capital as a commodity, a firm that credibly adds something beyond money is more likely to win a contested deal.

What PE Firms Actually Do

The work of a PE firm falls into three broad areas: finding and closing deals, overseeing portfolio companies, and restructuring them to raise returns.

Deal Origination

PE firms compete for a limited supply of good companies, so finding deals early is valuable. Firms build relationships with M&A intermediaries, investment bankers, lawyers, accountants and other professionals who can refer acquisition candidates, and some employ staff who contact business owners directly. When a seller hires a banker, the banker usually runs an auction, which pushes up the price and lowers any one buyer’s chance of winning. A firm that hears about a company before an auction starts, or finds one that was never formally marketed, may face less competition and pay lower intermediary fees.

Evaluation and Due Diligence

Once a firm finds a target, its deal team assesses the management team, the industry, historical financial statements and forecasts, and builds valuation models. The tools overlap heavily with public-market fundamental analysis, except that the buyer usually gets far more internal information and can negotiate for more.

If the firm’s investment committee approves, the deal team submits an offer. If the seller accepts, the firm brings in investment bankers, accountants, lawyers and consultants for due diligence: verifying the financial and operational figures management has presented. This stage can uncover deal-killers, such as large undisclosed liabilities, pending litigation or customer concentration risk, that lead the buyer to renegotiate the price or walk away.

Portfolio Oversight

After the deal closes, the PE firm becomes an owner with board seats and, in a buyout, control. Oversight takes different forms depending on the company:

• For younger companies, PE professionals may coach executives on strategic planning and financial management and help install new accounting, procurement and IT systems.
• For established but underperforming companies, firms look for operational efficiencies, pricing changes, better purchasing, and growth through add-on acquisitions.
• Across the board, firms tie management pay to results. Executives at portfolio companies commonly receive equity and bonus structures that reward hitting financial targets, and agreeing on these incentives is usually part of closing the deal.

Supporters of the take-private model argue that removing quarterly earnings pressure and public reporting lets owners and managers make longer-term decisions. Critics respond that the four-to-seven-year holding period creates its own short-term pressure.

Cost Cutting, Asset Sales and Debt

Raising profitability can come from growth, new products or wider market reach. It can also come from more aggressive measures:

• Asset sales: selling divisions, real estate or other assets to simplify the business or raise cash.
• Cost reduction: layoffs, cuts to benefits, closing locations or scaling back operations.
• Debt loading: financing the acquisition, or later a special dividend to the fund, with borrowing that the company must repay from its own cash flow or asset sales.

How Private Equity Makes Money

Two separate questions are bundled here: how the firm gets paid, and how the investment produces a return.

How the Firm Gets Paid: Fees and Carried Interest

The traditional fee model is known as “2 and 20”:

• A management fee of about 2% a year, charged on committed or invested capital, which covers salaries, office costs and deal searches.
• Carried interest (the “carry”) of about 20% of the fund’s profits, paid to the GP when investments are sold at a gain.

Actual terms vary from fund to fund. Many funds also include a preferred return (hurdle), meaning LPs must receive a minimum annual return on their capital before the GP earns carry, and a waterfall that sets the order in which proceeds are paid out.

A simplified hypothetical: a $1 billion fund charging 2% collects $20 million a year in management fees. If, by the end of its life, the fund returns $1.8 billion to investors, the profit is $800 million, and a 20% carry would be $160 million to the GP. This example ignores the hurdle, catch-up provisions and the fees themselves. Because a firm managing $1 billion might employ no more than two dozen investment professionals, both fee streams are spread across a small team, which explains why pay in the industry is high.

In the U.S., carried interest is generally taxed as a long-term capital gain rather than ordinary income, provided the underlying investments are held long enough. The 2017 Tax Cuts and Jobs Act lengthened that holding requirement to three years, but the preferential treatment remains, and it has been a recurring subject of debate in Congress. More broadly, PE firms use legal structures to reduce taxes, which adds to arguments over the industry’s economic role.

How the Investment Produces a Return

At the portfolio-company level, returns come from a few levers:

1. Earnings growth. The central metric is EBITDA (earnings before interest, taxes, depreciation and amortization). Firms work with management to increase it, both organically and by acquiring smaller competitors.
2. Multiple expansion. Selling at a higher valuation multiple than the purchase multiple. Larger companies tend to command higher multiples than smaller ones, which is one reason PE firms consolidate fragmented industries: combining several small companies into one bigger platform can raise the multiple applied to the combined earnings.
3. Debt paydown. As the company uses its cash flow to repay acquisition debt, more of the company’s value belongs to the equity holders, as the LBO example above shows.
4. Cash extraction. Dividends or a dividend recapitalization, where the company borrows to pay the fund a dividend, return cash before an exit. This lowers the fund’s risk and raises its reported return but increases the company’s debt.

Service companies are frequent targets for this playbook because many have recurring revenue, modest capital needs and fragmented markets that lend themselves to add-on acquisitions.

Measuring Returns

PE performance is reported differently from public funds. The two main measures are the internal rate of return (IRR), which accounts for the timing of capital calls and distributions, and the multiple of invested capital (MOIC) or total value to paid-in (TVPI), which compares what investors get back (and still hold) with what they put in. A high IRR can come from a quick sale with a modest multiple, while a high multiple achieved slowly can produce a lower IRR, so investors look at both. Comparing PE returns with an index such as the S&P 500 is harder than it looks, because PE cash flows are irregular and unsold holdings are valued by the managers themselves rather than by a market price.

How PE Firms Exit Investments

A PE fund must eventually turn its holdings back into cash. The main exit routes are:

• Sale to a strategic buyer. A larger company in the same or a related industry buys the portfolio company, often paying more than a financial buyer would because it expects cost savings or new sales from combining the businesses. A common playbook is to grow a middle-market company and sell it to a large corporation.
• Secondary buyout. Another PE firm buys the company, sometimes because it sees a further stage of growth or a fresh round of add-on acquisitions.
• Initial public offering (IPO). The company lists on a stock exchange. The fund often sells only part of its stake at the IPO and the rest in later offerings, so public market conditions affect both timing and price.
• Recapitalization. The company refinances or borrows to pay out the fund, returning capital without a full sale.
• Continuation vehicles. A GP moves a company it wants to keep into a new vehicle, letting existing LPs either cash out or roll their stake forward.

The middle market gets particular attention. Many large firms chase the biggest deals (in 2024, 31% of U.S. PE deals were valued at over $1 billion), while there are more middle-market sellers than experienced buyers with the networks to manage those deals. Smaller companies may offer niche products or stronger customer service than large competitors, and a PE owner can try to expand them, for example by opening international sales channels for a regional company.

The Case Against Private Equity

Criticism grew as the industry expanded through the 2010s. The main arguments:

• Short horizons and limited commitment. With a target holding period of four to seven years, critics argue PE owners lack the long-term commitment or specialized expertise that founders or industry operators bring.
• Cost cutting that hurts people. Layoffs, benefit reductions and closures can deeply affect employees and local communities.
• Excess debt. Leveraged buyouts can leave companies with debt loads that make them fragile in a downturn and raise the risk of bankruptcy.
• Tax treatment. The capital gains treatment of carried interest strikes many as a subsidy for highly paid managers.

High-profile cases have kept these criticisms in the news. The 2017 bankruptcy of Toys “R” Us was widely linked to the debt from its earlier buyout. Taylor Swift’s decision to rerecord her albums followed the sale of her master recordings in a deal involving private equity. A 2023 study in the Journal of the American Medical Association found an increase in hospital-acquired adverse events after private equity acquisitions of hospitals. In 2024, mass layoffs at Sports Illustrated drew attention to PE ownership in media.

The Case for Private Equity

Supporters argue PE plays a useful economic role:

• It can inject capital into struggling companies, potentially saving them from bankruptcy and preserving jobs.
• Its owners bring financial resources and strategic expertise to carry out changes that a company’s previous owners could not or would not make.
• Its returns flow largely to pension funds, endowments and foundations, so retirees, students and charitable beneficiaries share in the gains.

U.K. researchers John Gilligan and Mike Wright, in a widely used textbook on the industry, argue that many concerns come from cherry-picked cases or unrepresentative corners of the market. They call for more balanced studies that weigh all relevant perspectives, not just those of managers, PE firms, employees or unions. Outcomes vary widely by deal, sector, leverage and owner.

Risks and Drawbacks for Investors

For an investor considering PE exposure, the main drawbacks are:

• Illiquidity. Money committed to a fund is typically locked up for years, and selling a stake early usually means going through the secondaries market, often at a discount.
• High fees. Management fees, carry, deal fees and fund-of-funds layers can absorb a large part of gross returns.
• Leverage risk. Buyout returns depend on borrowing, which magnifies losses when a company underperforms or when rates rise.
• Execution risk. Winning a deal at a reasonable price, improving the business and finding a buyer are all difficult.
• Valuation uncertainty. Because managers mark unsold holdings, reported values can lag reality and make PE look smoother than it is.
• Manager dispersion. Results vary widely between top and bottom funds, so choosing a manager matters as much as the decision to invest.
• Concentration and limited control. A fund may hold relatively few companies, and LPs have little say in decisions.

Ways for Individuals to Invest in Private Equity

Publicly Traded Private Equity Firms

Several large PE managers list their own shares, including Blackstone (BX), KKR (KKR), Apollo Global Management (APO) and Carlyle Group (CG). Owning these shares means owning the management business: its fee income, carried interest and balance sheet. It does not give a proportional stake in each fund’s portfolio companies, and the shares move with the stock market as well as with the firm’s own fundraising and exit activity.

Business Development Companies

Business development companies (BDCs) are a separate structure created by U.S. law to invest in small and mid-sized private companies, mostly through loans and sometimes equity. Many trade on exchanges. They must distribute most of their taxable income, so they tend to pay high dividends, but their holdings are largely private credit rather than buyout equity.

Private Equity ETFs and Mutual Funds

Exchange-traded funds such as the ProShares Global Listed Private Equity ETF (PEX) hold shares of listed PE firms and similar companies, offering diversified, liquid exposure to the industry’s publicly traded side. Traditional open-end mutual funds face SEC liquidity rules that limit illiquid holdings to 15% of net assets, so they generally cannot hold private funds in size. Some get exposure indirectly by holding listed PE companies.

Equity Crowdfunding

Equity crowdfunding lets startups and small businesses raise money online from many investors, who receive shares or debt in return. Platforms have included Wefunder, AngelList, Crowdfunder, SeedInvest and CircleUp. The SEC’s Regulation Crowdfunding caps how much a company can raise over a 12-month period and how much non-accredited investors can put in, based on their income and net worth. These investments are mostly in very early-stage companies, are hard to sell, and carry a high risk of total loss.

FAQs

The Bottom Line

Private equity matters most to accredited investors weighing a fund commitment and to people whose pensions or endowments hold PE stakes. The potential for higher returns comes with years of lock-up, high fees, heavy leverage and wide gaps between top and bottom managers, so manager choice carries as much weight as the decision to invest. Individuals who do not qualify can get indirect exposure through listed PE firms, BDCs or ETFs, which behave more like stocks than like PE funds.