What is Private Equity?

It’s an exciting, lucrative and occasionally cut-throat area of finance – but what does it really involve and how does it work? Read on to learn the basics of private equity investment.

How to make money from buying up companies

Quick definitions

Equity is a type of asset. You can think of it as the value of a company. If you own 10% of a company’s shares, you own 10% of its total value – so you have 10% equity.

Private equity is a term for investing in private companies – ones that aren’t traded on the stock market and don’t have shares. Most private companies are reasonably new and therefore unpredictable. They can be risky investments because the company could easily fail.

Who invests in private equity?

Family and friends are the initial source of funding for most start-ups. These investors – sometimes called ‘angels’ – usually invest very early on before the company even has a product prototype. They offer loans because they want to support the owner.

Venture capitalists are individuals or groups of investors who invest directly in small companies. They may well be successful entrepreneurs with an eye for a workable business plan.

Private equity firms tend to invest in larger companies and make eight or nine figure deals. They perform in-depth analysis of companies and invest funds for individual or institutional clients. Private equity careers can be among the most lucrative in finance.

Investment banks often make referrals or broker deals for private equity firms. They also invest in their own right, meaning they compete directly with private equity firms.

Why do you need to know about private equity?

Even if you’re not directly focused on a private equity career, anyone going into the finance industry should understand the basics. It’s vital to your understanding of the stock market as a whole and how companies grow and develop financially.

You will be expected to be able to discuss private equity with confidence in an interview for investment banking, accountancy or even management consultancy.

Five things you should understand about private equity

To get you started, here are a few key concepts about private equity.

1. Managed or not?

Some investors just provide capital to boost the company’s growth and leave the company to manage itself, but usually private equity companies take on management responsibility. They implement their own business strategies and attempt to increase the value of their investment.

2. Debt vs equity

To protect their investments, some investors buy up part of a company’s equity and also lend money to be repaid with interest. This means not all of their money is at risk if the company’s value plummets – they may lose a lot on their equity investment but will still be owed what they lent.

3. Combining smaller companies

A common strategy for private equity companies is to buy up several competing small companies and combine them into one. This larger company is more valuable than the individual pieces and combines the market share of the others.

4. Exit strategies

An exit strategy is a long-term plan to convert a private equity investment back into money. Investors usually plan for one of two things:

  • The company is bought by another company and they get a share of the money from the sale
  • The company starts to be traded on the stock market and the investor’s equity is converted into shares which they can sell

This makes private equity one of the least liquid assets – it’s very slow to convert to cash. 

5. Leveraged buyout

A leveraged buyout is a technique private equity companies use to acquire very expensive companies while spending very little money directly. They borrow enough money to buy the company, using that company’s assets as collateral. It’s exactly like taking out a mortgage to buy a house – 10% deposit and 90% borrowed money, with the house itself as collateral. It can be considered quite a ruthless tactic.

Landing a career in private equity

Private equity is one of the most lucrative finance careers. There’s a lot of competition for positions. As a student or new graduate, your best way into a private equity career is via an investment bank. Private equity firms rarely hire directly from university. They headhunt top talent with at least a couple of years of financial experience.

You’d begin your career as a graduate analyst, supporting the partners in bringing new deals together. Your job would include:

  • analysing the economics of companies and potential deals
  • researching new deals and investment areas
  • preparing documentation for partners
  • coordinating the research and due diligence needed for the deal to go ahead

Where can you go to learn more about private equity?

In the news

Get the latest stories about private equity companies from news sites such as Reuters.

At your university

Speak to your careers service to find out if any private equity companies plan to attend careers events, and reach out to alumni who have gone on to careers in private equity.