Private-equity firm

A private-equity firm is an investment management company that provides financial backing and makes investments in the private equity of startup or operating companies through a variety of loosely affiliated investment strategies including leveraged buyout, venture capital, and growth capital. Often described as a financial sponsor, each firm will raise funds that will be invested in accordance with one or more specific investment strategies.

Diagram of the structure of a generic private-equity fund

Typically, a private-equity firm will raise pools of capital, or private-equity funds that supply the equity contributions for these transactions. Private-equity firms will receive a periodic management fee as well as a share in the profits earned (carried interest) from each private-equity fund managed.

Private-equity firms, with their investors, will acquire a controlling or substantial minority position in a company and then look to maximize the value of that investment. Private-equity firms generally receive a return on their investments through one of the following avenues:

  • an initial public offering (IPO) — shares of the company are offered to the public, typically providing a partial immediate realization to the financial sponsor as well as a public market into which it can later sell additional shares;
  • a merger or acquisition — the company is sold for either cash or shares in another company;
  • a recapitalization — cash is distributed to the shareholders (in this case the financial sponsor) and its private-equity funds either from cash flow generated by the company or through raising debt or other securities to fund the distribution.

Private-equity firms characteristically make longer-hold investments in target industry sectors or specific investment areas where they have expertise. Private-equity firms and investment funds should not be confused with hedge fund firms which typically make shorter-term investments in securities and other more liquid assets within an industry sector but with less direct influence or control over the operations of a specific company. Where private-equity firms take on operational roles to manage risks and achieve growth through long term investments, hedge funds more frequently act as short-term traders of securities betting on both the up and down sides of a business or of an industry sector's financial health.[1]

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