Inside the World of the Private Equity Buyout Industry

Private equity buyouts are generally conducted by private partnerships that involve three main actors: 1) investors, 2) private equity firms and 3) the companies they purchase, known as “portfolio companies.”

Investors in private equity are typically institutional investors such as pension funds, insurance companies and endowments, as well as high net-worth individuals. These investors are commonly referred to as “limited partners”; they have limited liability, but also limited control over the management of the funds. They invest significant amounts of assets in private equity funds for a fixed period of time, usually 10 years, during which time they cannot access their investment. At the end of the fixed period, the funds must be returned to the limited partner investors.

Most of the control of the investments remains in the hands of the private equity firms themselves, often referred to as the “general partners.” They are responsible for raising the money for the funds, which can vary in size from $5 million to $10 million for a small venture capital firm to more than $15 billion for a very large buyout firm.

A typical private equity firm will raise a new fund every three to four years. Each fund becomes the private equity firm’s working capital for a new wave of investments in portfolio companies. The firms also work to identify, acquire, and manage all the portfolio companies in which they invest their funds.

Once a private equity buyout firm has invested in a portfolio company, it usually assumes complete control of the company. It may keep the company’s senior managers in place or it may bring in outside managers of its choosing. Even if the portfolio company’s management remains in place, a member of the buyout firm typically joins the board and the firm has final say over how the company is run. After a period of ownership, the private equity firm will sell its stake in the portfolio company on a stock market through an Initial Public Offering (IPO), to a larger company in the same industry or to another private equity firm.

Over the past 20 years, private equity has outperformed the S&P Index, a common benchmark for stock market investments, by up to 44 percent. Private equity can offer higher returns than traditional investments such as stocks and bonds, but private equity investments are also riskier because they are less diversified and more difficult to sell.