Private Equity
What It Is
Private equity (PE) refers to investment in companies that are not listed on a public stock exchange. Funds pool capital from institutional and high-net-worth investors and use it to acquire, invest in, or develop private companies, with the goal of generating a return when they exit – typically via a sale or IPO.
The main sub-strategies are:
- Buyout – Acquiring a controlling stake in a mature company, often using significant debt (leveraged buyout / LBO). The GP seeks to improve operations and sell at a profit.
- Venture Capital (VC) – Early-stage investment in startups with high growth potential. High risk, high return dispersion.
- Growth Equity – Minority or majority investment in established, growing companies that do not require operational transformation.
Why Investors Use It
- Return premium – PE has historically delivered higher returns than public equities over long time horizons, partly as compensation for illiquidity.
- Control – Buyout GPs can actively shape company strategy, unlike passive public market investors.
- Diversification – Low correlation to daily public market movements (though this partly reflects infrequent valuation).
- Access – Many high-quality companies remain private for longer or indefinitely.
Typical Structures
PE funds are almost universally structured as limited partnerships. The GP manages the fund; LPs commit capital. Funds are closed-ended, typically with a 10-year life (often extended). Capital is not invested upfront – it is drawn via capital calls over an investment period (usually 3–5 years).
Co-investments alongside PE funds are common for large LPs. Secondaries allow LPs to sell their fund interests before maturity.
Key Risks
- Illiquidity – Capital is locked up for years with limited exit options.
- Leverage risk – Buyouts use debt, amplifying both gains and losses. See leverage-risk.
- Valuation uncertainty – Private company values are estimated, not market-traded. See valuation-risk.
- Concentration – Funds may hold 10–20 positions; a few bad exits can materially hurt returns. See concentration-risk.
Key Metrics
| Metric | Use |
|---|---|
| IRR | Annualised return, accounting for timing of cash flows |
| MOIC | Total money returned as a multiple of invested capital |
| TVPI | Total value (realised + unrealised) to paid-in capital |
| DPI | Realised distributions only; a measure of cash returned |
| RVPI | Unrealised value still held in the fund |
Operational Considerations
- Investors must respond to capital calls on short notice (typically 10–15 business days).
- Distributions are irregular and unpredictable.
- NAV is calculated quarterly, not daily.
- Investor reporting includes capital account statements, quarterly reports, and annual audited financials.
Related Concepts
Reading PE Performance Metrics Together
PE metrics are only meaningful in combination. A fund reporting a single metric in isolation is not giving a complete picture. The recommended minimum reporting set is:
| Metric | What It Shows | Key Caveat |
|---|---|---|
| Net IRR | Annualised time-weighted return after fees | Early-stage IRR unreliable; subscription lines can inflate |
| Net MOIC / TVPI | Total value multiple (realised + unrealised) | RVPI component is soft – depends on valuations |
| DPI | Cash actually returned to LPs | The most reliable metric; cash is harder to manipulate |
| RVPI | Remaining unrealised portfolio value | GP estimate only; may compress at exit (exit drag) |
| PME | Performance vs public markets | Method-dependent; benchmark must match strategy |
For a fund with low DPI and high TVPI, the key question is: “When will the unrealised value be realised, and at what price?” For a fund with high DPI, the track record is more established. Both situations require contextual interpretation.
Manual Review Notes
- The claim that PE has “historically delivered higher returns than public equities” is directionally supported by industry research (e.g., Cambridge Associates, Preqin benchmarks) but the evidence is debated. Performance depends heavily on vintage year, manager quartile, strategy, and how returns are measured (IRR vs PME). Avoid stating this as a settled fact in formal documents.
- The “10–20 positions” concentration figure is illustrative for buyout funds. VC funds may hold 20–50 or more positions; large buyout funds may hold fewer. Adjust based on context.