Understanding Private Equity: Definition, Process, and Examples

Pooled money from large investors and rich individuals is used in private equity for buying shares in private companies or taking public companies private. Private equity firms or fund managers look after these investments by buying, reorganizing and improving businesses before eventually offering them for sale to generate a profit.

So, how does private equity happen in reality?

Most private equity funds are set up as limited partnerships. The investment decisions and portfolio management are the responsibility of the general partners (GPs). The investors who provide the capital are known as limited partners (LPs). After the fund is closed (i.e., investment ends), the GPs use the money to buy companies that, in their opinion, could benefit from improvements. When the PE firm is satisfied with the restructuring and value growth achieved, it generally exits the deal, selling off its ownership or allowing the company to launch an initial public offering (IPO).

How Private Equity Generates High Returns for Investors

Private equity stands out because it generally provides much higher returns than other investments. What methods are used to bring about this result?

1. Active management: Private equity firms help shape and improve their investment firms. Some areas for this are enhancing how operations run, altering leadership roles, transforming technology and enlarging the business structure.
   
   

2. Leverage: a popular way in private equity to finance the purchase of a company using both equity and loans. If there is more leverage, returns rise even more if the business does well.
   
   

3. Long-term horizon: Unlike public markets that move according to quarterly earnings, private equity investments last for 5–7 years which helps to transform businesses and increase value.

4. Alignment of interest: Many fund managers use their own investments, so they feel invested in the results as LPs do.
   
   

By using these approaches, private equity generates good risk-adjusted returns, mainly for people interesting in alternatives to unpredictable public markets.

Common Private Equity Investment Strategies Explained

Depending on the amount, level and aims of the investment, fund managers generally use several common strategies for private equity assets.

• Leveraged Buyouts (LBOs):  often used to buy and improve a mature business in the hopes of exiting for a profit by repaying the loan and keeping the gain.
  
  

• Growth Equity:  Wants to help invest in companies that are fast-growing and direly need additional funding. Companies in this area just require funding to increase their scale.
  
  

• Venture Capital (as a subset): Technically different, some Private Equity firms may invest in startups and fast-growing businesses.
  
  

• Distressed Investments: Utilizes buying firms that are in trouble with the goal to help them succeed.
  
  

• Secondary Investments: You can also look for “secondary investments” by buying already-held shares in private equity funds from other investors.
  
  

Fund managers choose a strategy by looking at its risks and expected return and by matching it to the fund’s overall investment goals and the kinds of investors targeted.

Best Private Equity Course for Finance Professionals

Many trained professionals in finance gain further practice and credentials through taking the best private equity course available. Usually, a high-quality course contains the following:

• Finding deals and checking if they are a good fit
  
  

• Ways to determine the value of private companies
  
  

• Performing a leveraged buyout model with Excel
  
  

• Handling and managing the structure of funds and investors
  
  

• Understanding how businesses should be exited and reviewed.
  
  

Riverstone Training, Wharton Executive Education and Wall Street Prep provide in-depth training that mixes theory with real life examples. For anyone in finance, aiming to join investment banking, asset management or private equity, these courses greatly help with career movement.

How to Evaluate Private Equity Returns and Performance

Considering private equity returns needs to go past just checking the annual average rate of return. Regularly checked performance metrics are usually:

• Internal Rate of Return (IRR): assesses annual returns, taking into account the time at which each cash flow occurs. If an investment has a high IRR, it generally means that it is more successful.
  
  

• Multiple on Invested Capital (MOIC): Shows how much income was produced from the original investment, without taking time into account. For example, a 3x MOIC shows the initial investment became three times larger.
  
  

• Public Market Equivalent (PME): PE fund performance is measured against popular benchmarks, often including the S&P 500 to find out if the fund did well compared to the market.

• Cash-on-cash return: measures how much cash comes back in comparison to the investment made.
  
  

Assessing the returns of a PE fund means looking at both the timing of those returns and how much risk was involved. Both carried interest (a fee paid to GPs for their work) and management fees should be taken into account to calculate net returns.

Differences Between Private Equity and Public Equity Investments

When comparing private equity vs public equity investments, several keys differences emerge:

• Liquidity: Public equities enable investors to sell or purchase shares very quickly on the stock exchange. These types of investments do not allow for quick access to funds and must be held for a long time (typically at least 5 to 10 years).
  
  

• Control and influence: Most PE firms influence business decisions heavily, whereas with public equity such influence is generally much less.
  
  

• Transparency: Public companies are required to follow strict standards on how they reveal their information. Private companies are not subject to the same regularity or detail in their reporting as public companies.
  
  

• Volatility: Public equities depend on financial news, the economy and how investors feel, they can experience market swings. Not enough transparency comes with private equity, though it shows a more stable evaluation.
  
  

• Returns: It is possible to make a lot with private equity and public markets, though private equity tends to be more beneficial in the long run because of how it is managed and its various advantages.
  
  

Usually, these distinctions matter a lot to individuals making investment decisions according to their preferences and how much risk they want.

Conclusion

Those who manage private equity well, have reshaped many industries and gained impressive profits. Explaining both the process and key strategies of private equity plays a big role in taking full advantage of its benefits.

For people interested in entering or progressing in private equity, taking the top finance professional course is key. Through the program, you will develop skills in financial modeling, valuing companies, organizing funds and assessing performance which help you stand out in the industry.

Having a basic understanding of private and public equity investments and how to analyze fund performance helps you make better decisions and benefit from good opportunities.