The ABCs of Private Equity

Understanding How Private Equity Works

If you’ve been following the financial news, chances are you’ve been hearing more talk these days about “private equity”. This comes as no surprise, considering that in recent years PE or private equity has become a prevalent option amongst retail investors and financial professionals alike.

Private equity offers an alternative to traditional types of investments. It’s essentially capital or shares of ownership that are not publicly traded or listed, in the way that stocks are in the public markets.  While highly influential in today’s financial landscape, there are still many who do not understand the ins and outs of private equity investing. Below, you’ll find a brief overview of what PE is, how it works and why so many people are jumping on the PE bandwagon.

What is private equity?

As the name suggest, private equity is in something that is private (e.g. not publicly listed or traded) such as privately held companies. PE funds are formed by investors who want to purchase shares of ownership in a private company, rather than buying stocks or bonds. Typically, stocks and bonds are only offered by corporations who have the resources to provide these opportunities; which most private companies do not have at their disposal. In many cases, PE firms will purchase the whole company, which is why private equity investments most often take the form of a business loan or acquisition.

How does it work?

Private equity funds use investor capital to purchase shares in privately held companies. The investment from the purchase is then used to boost the company’s value, either by increasing growth or cutting costs. The goal is to gradually enhance the value of the company and then sell the company to make a profit.

Not unlike hedge or mutual funds, PE funds receive an annual fee on the money invested. While the fee structure for firms can vary, it often consists of a management and a performance fee.

What are the advantages?

There is certainly a great potential for return on private equity investments. Additionally, it is a unique opportunity in that it offers investors a way to leave their investment in the hands of an experienced professional who will pool it with other invested money and distribute the profits. With multiple investors, it gives individuals the resources to invest in ways they might not have been able to on their own.

Are there any disadvantages?

Due to the nature of private equity investments, yielding a positive return can take some time. Generally, investors will have to wait for their investment to boost the company’s performance (and therefore profits) before receiving their return. A typical investment horizon for private equity is between four and seven years. Additionally, as with any investment there is risk involved. If the company’s performance stumbles, the investment will lose money.

Hopefully you now have a better understanding of what private equity is, how it works and also why it’s become such a common option among industry professionals. However, if you’re interested in investing more time in learning about PE funds, the best return will always come from contacting a financial professional.

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