A Comprehensive Guide to Private Equity Investing

Private equity, in simple terms, is the investment of capital in non-public companies through privately-negotiated transactions and results in the private ownership of businesses. The industry has grown exponentially over the past 35 years and is projected to surpass $11 trillion in assets under management in 2026.[1]

While most private equity transactions involve investments in private companies, they can range from the financing of start-up entities, to infusing growth equity into an expanding company, to buying out mature public or private enterprises. What is common to most private equity investments is that the investor group often acquires a large or significant ownership stake in the company through a highly structured and negotiated transaction.

Typically, private equity managers take an active role in monitoring and advising their portfolio companies. Through this “hands-on” approach, private equity managers seek to create value and enhance returns by directly influencing a company’s strategy and performance, as well as the timing of the exit from the investment, whether through a sale to a strategic (e.g., a corporation) or financial buyer (e.g., another private equity firm) or via an initial public offering (“IPO”).

Introduction to Private Equity

A private equity investment can occur at virtually every stage of a company’s life cycle. Four common subclasses of private equity are: 

1. Venture Capital
2. Leveraged Buyout
3. Mezzanine Debt
4. Distressed Debt

Venture Capital 

Venture capital (“VC”) is an important source of financing for start-up companies, or those in the early process of developing products and services that do not yet have access to public funding by means of stock offerings or debt issues. Most VC investments are in rapidly growing companies, with a heavy concentration on the technology or life sciences sectors. There are several stages of VC investing, which often mark financial and/or operational milestones for the VC-backed company. As these companies grow and proceed from one round of financing to the next, their valuations often increase. These rounds are often referred to as series A, B, C and so on. Sometimes, VC investments may begin with a “seed” round, which involves initial start-up capital. Generally, early-stage VC investors seek to acquire relatively large ownership interests in their portfolio companies to maximize the proceeds they receive at exit value. Because companies in the early rounds of VC investing have higher risk profiles, their valuations tend to be lower—although the potential for significant value appreciation is higher. The risk associated with venture capital is heightened by the fact that the companies may have little or no track record. VC-backed companies may have unproven management teams and products, and may be generating very little in terms of revenues or earnings.

Leveraged Buyout

A leveraged buyout, also referred to as a “buyout” or “LBO,” is a strategy that typically involves the acquisition of a relatively mature business, from either a public or private company. As the name implies, leveraged buyouts are financed with debt, commonly in the form of bank debt or high-yield bonds. Typically, these securities, especially the high-yield bond portion, are either rated below investment grade or unrated. During the early 1990s, many LBO transactions required only 20-25% in equity to finance their purchases. By contrast, median equity contributions to LBOs have exceeded 65% in recent years, largely due to more conservative underwriting assumptions and greater availability of equity capital.

Strategies among LBO firms can differ considerably. Some focus on consolidating large, fragmented industries. This is also known as a “buy-and-build” strategy. By contrast, other firms focus on turnaround or operational improvement situations. There are also “growth-oriented” LBO firms that will purchase unwanted business units, such as a division of a larger corporation that is deemed nonessential to the core business or parent company. With the capital investment and strategic direction that an LBO firm provides, these businesses could be revived and potentially transformed into high-growth companies. Many LBO firms employ former senior executives with significant operational experience—commonly from industries that comprise the firm’s investment targets—to bring unique insight and a competitive edge to their investment decisions.

Investors should be aware that buyouts have heightened investment risks, including the use of significant leverage in a portfolio company’s capital structure. In addition, while the difficulties that exist in various industries and sectors may present buyout opportunities, they also present risks.

[1] 2022 Preqin Global Private Equity Report