Private equity (PE) may sound like a high-stakes game meant only for the Wolfe’s on WallStreet, but understanding its basics and benefits can give anyone a clearer picture of this powerful investment strategy. Whether you’re an investor, an employee at a company backed by private equity, or simply a curious observer, PE touches more lives and industries than you might think.

This blog will guide you through what PE is, how it operates, and why it matters for employees and investors. We’ll also explore the associated risks and when it might be the right choice for your portfolio.

What Is Private Equity? 

At its core, private equity refers to investments in companies that aren’t publicly traded on stock markets. While public equity (like investing in shares of Apple or Amazon) is accessible to everyday investors, PE deals with private companies, often those with high growth potential or untapped opportunities.  

Most PE investors are institutional (think pensions, endowments, or sovereign funds), but high-net-worth individuals can also participate. Individual investors must typically be “accredited investors” to gain access to this type of investment. PE investments are typically made via funds managed by private equity firms that buy stakes (often majority control) in companies to improve their performance and realize profits through later sales or other "exit strategies." 

Nerd Note: Around 86% of companies with revenues over $100 million are privately held, making PE a gateway to a massive chunk of the global market overlooked by public equity investors. 

Why Private Equity Matters for Employees 

If you’re an employee at a company backed by PE, you’ve probably noticed operational changes after the firm stepped in. This isn’t uncommon, as PE firms don’t just inject capital—they often actively participate in improving company performance. 

Common changes include new leadership hires, shifts in strategy, or process overhauls. While this can lead to better long-term outcomes, it may involve growing pains, such as restructures or increased demands for efficiency. These changes are aimed at boosting profitability and preparing the company for an eventual IPO or sale. 

What This Means for Employees:

• Opportunities for Growth: New capital might lead to expanded operations and career advancement opportunities within the company.
• Potential Risks: Restructures or changes in direction sometimes lead to layoffs or cultural shifts.
• Upside for Equity Holders: If you’ve been granted stock options or shares in your company, a successful PE-driven transformation could significantly boost their value.

Nerd Note: One notable example is Hilton Hotels, where Blackstone acquired the chain in 2007, implemented operational improvements, and later took it public again in 2013 and successively exited their position. Blackstone ultimately exited with over $14 billion in profits! 

Why Private Equity Matters for Investors 

For investors, private equity offers an opportunity to diversify portfolios and potentially achieve higher returns compared to public market investments. 

Key Advantages:

1. Higher Returns: Historically, PE has outperformed public markets, delivering an annualized return of ~15%, compared to 9% for public equities.
2. Diversification: PE allows access to sectors and companies not available via traditional stock markets, spreading risk across different segments.
3. Value Add Potential: Unlike public investors, PE firms often take an active role in improving their portfolio companies, potentially creating new value and profitability.

However, the potential rewards come with risks, which include the following:

Key Risks:

• Illiquidity: PE funds often lock up capital for 10+ years. Be sure you won’t need that money anytime soon!
• High Fees: Investors typically pay hefty fees, 2% management fees and 20% performance fees are common, much of the time outweighing the added returns.
• Uncertainty: Returns aren’t guaranteed, and success depends on factors like market conditions, manager expertise, and strategic execution.

Nerd Note: The illiquidity risk is balanced by an "illiquidity premium," meaning PE investments are often rewarded with higher returns for the patience required. 

The Mechanics of Private Equity 

To better understand how PE works, consider it a focused, hands-on investment strategy. Here’s what happens step by step in typical PE operations:

1. Raising Funds: PE firms raise money from limited partners (LPs), which may include institutional investors or high-net-worth individuals. Once the fund is closed, these funds are strategically deployed over time.
2. Acquiring Companies: Target companies might be family-run businesses seeking succession plans, underperforming companies ripe for a turnaround, or startups in growth stages. Firms often use a mix of their equity and borrowed debt for acquisitions, a strategy known as a leveraged buyout (LBO).
3. Improving Operations: Once acquired, PE firms implement value-driven changes, such as operational streamlining, new leadership, and capital investments.
4. Exiting Investments: After years of growth and improvement, companies are generally sold via IPOs, mergers, or acquisitions, realizing gains for investors.

Types of Private Equity Strategies:

• Buyouts (LBOs): These entail purchasing companies outright, often using debt. Blackstone’s Hilton acquisition is a prime example.
• Growth Equity: Focuses on minority stakes in fast-growing companies. While these provide less control, they can result in lucrative exits through IPOs or sales.
• Distressed Investments: PE firms invest in struggling companies, turning them around for high-risk, high-reward payoffs.

Keys to Success in Private Equity 

For investors looking to dip their toes into PE, here are things to consider:

• Understand Your Time Horizon: Can you lock up funds for 10+ years without needing access? If not, PE might not be the right fit.
• Align with Your Risk Tolerance: PE involves higher risk and fees. Make sure the potential rewards match your financial goals and capacity for risk.
• Consider Different Structures: If traditional PE feels too intimidating, other options like "funds of funds" or evergreen funds might be a better entry point.
• Choose the Right Manager: The success of PE investments often depends on the manager. Look for firms with proven track records in the specific strategies and sectors you’re targeting.
• Understand the Fee Structure: Often, managers charge a baseline ~2% fee with performance “catch-ups” and “waterfalls”, so it’s easy to get confused how much you pay. Some managers charge their fee on the full commitment amount even before all funds are allocated, making this expense much higher when little is working in the markets for you. Know what you are paying for, if it’s ambiguous, it’s probably higher than you think.

Nerd Note: Some evergreen PE funds offer liquidity "windows", making them slightly more flexible than traditional PE investments where you are able to exit sooner. 

Is Private Equity Right for You? 

Private equity isn’t for everyone, but for the right investor, it can open doors to exciting opportunities, higher returns, and enhanced diversification. Employees at PE-backed companies also gain professional growth and financial upside, though not without potential challenges. 

If you’re ready to explore private equity or add it to your portfolio, make sure you carefully weigh the pros and cons, work with reputable managers, and fully understand the implications of long-term commitments. 

Want to know more or seek guidance specific to your financial goals? At HealthyFP, we specialize in empowering individuals and organizations to make informed investment decisions. Contact us today to discuss your investment strategy or portfolio planning.