What Does Private Equity Mean? Terminology and Facts to Know

If you have wanted to be more financially savvy, you likely want to know more about private equity and how to use it to your advantage. In 2019, about $3.9 trillion worth of assets were held by these kinds of firms. So, what does private equity mean? 

Private equity is a form of private financing that is not listed on the public exchange. Investors put money into companies or invest in buyouts of companies. Keep reading to learn everything you need to know about private equity. 

What Does Private Equity Mean

Private equity is an alternative type of investment strategy. It has capital that is not listed on the public exchange. It consists of funds and investors who invest their money in a company or buyout of public companies.

This type of investment usually comes from investors who can invest substantial sums of money for long periods. The private equity terminology for this is institutional and accredited investors. 

Institutional investors are larger companies or corporations and not considered individual, or one person investors. They may be banks, insurance companies, or the like. 

These investors look for these kinds of opportunities to get better returns than they can get on the public market. This is usually open to people with a high net worth who can purchase stakes in private companies or gain control of public ones and then delist them from the stock exchange. 

How It Started

Although it may seem new to some, private equity is not a new concept. It started hundreds of years ago. Pooling money together is how the British North American colonies got built. 

After that, a few hundred years later, the railroad industry was having trouble with funding. They got bailed out by banks that bought controlling interests and restructured their operations by inserting new management. 

In 1901 JP Morgan paid $480 million for Carnegie Steel. It got turned into United States Steel, which was the largest company in the world back then.

Thus, some of the private equity terminology used today may be new, but the methods used are not. Using large sums of money to buy controlling interests in a company has been around for many years. 

This continued into the 1980s when the golden age of leveraged buyouts was booming. High returns encouraged more investments. Fund managers started leaving one firm to start new ones, thus making private equity firms grow exponentially. 

How It Works

This kind of investment is open to investors who can put out a lot of money. This is not the typical person next door who wants to start investing. Most funds start at $250,000 but can go up to millions of dollars. 

In getting familiar with private equity terminology, you will want to know the types of firms involved. These can be passive investors who depend on management to grow the company or active investors who contribute to the operational support to help grow the firm. 

You will want to familiarize yourself with the J Curve. This represents the returns made by private equity funds over time and gets shown on a graph. The shape when plotted looks like a “J”, giving it the name J Curve. 

The reason for private equity investment is always to get a positive return on investment. It may take years to achieve this so patience is important. 

Private Equity Advantages

Private equity offers liquidity to companies as an alternative to traditional financial methods. This removes the need for high-interest bank loans or having to list on public markets. 

Some forms of private equity finance early-stage companies and ideas. This is called venture capital. 

For companies that are delisted, the financing from private equity gives freedom for unique growth strategies. It lessens the pressures of quarterly earnings and allows senior management time to turn a company around or experiment with different ways to make money. 

Private Equity Disadvantages

There are some disadvantages to private equity. For one, it can be hard to liquidate holdings. This is because it can be hard to match buyers to sellers since it is not on the public market. 

A company has to search for a buyer. This takes time to make the sell of the company or investment. 

The prices of the shares are set by negotiations between buyers and sellers. They are not set by markets. 

The rights of shareholders are set on a case by case basis. There is not broad governance for how it is set. 

Things to Remember

Private equity can take on different forms. It can be venture capital or leveraged buyouts. 

These types of investments are usually available only to high net worth investors. It is a big business. According to the Harvard Business Review, private equity buyouts grew from $28 billion in 2000 to $502 billion in 2006. 

One of the biggest factors behind the growth and high rate of return of these private equity companies is their ability to buy a company that may be struggling and then turn it around. They do this by putting the company through a rapid performance improvement then selling them. This strategy is at the core of private equity’s success. 

Private equity often uses the buy to sell approach. It is always intended to buy as low as possible and then implement changes to make the company better, then selling it for a large profit. 

What to Know

Private equity is a big business. There is a reason why investors with money to spare invest in private companies. Most individuals cannot afford the huge stake it takes upfront. 

It takes time. Buying companies to sell takes time to turn them around and implement improvements. If you are in a hurry, private equity investments may not be for you. 

What does private equity mean? It is an alternative way of financing, away from public markets, and can be beneficial to investors looking for a large return on their substantial investment. Follow our website for more great tips!