At a high level, all “private equity” firms raise outside capital from Limited Partners (LPs) such as pension funds, endowments, sovereign wealth funds, and high-net-worth individuals. They then use that capital to acquire assets or companies, grow them over time, and eventually sell them to realize a return on investment.
However, the investment strategies used by these firms differ widely.
Some focus on large companies; some focus on smaller, high-growth firms; some focus on lending (i.e., investing in debt rather than equity); and still others focus on infrastructure or real estate assets rather than companies.
In growth equity, firms invest minority stakes into high-growth companies that need capital to scale their sales and marketing or geographic/industry presence.
It’s a mix between venture capital and private equity because firms do not use debt, but the companies they invest in are more mature than typical startups.
In mezzanine investing, firms invest in the higher-yielding and riskier tranches of company debt in leveraged buyout deals.
Mezzanine funds are similar to traditional PE in some ways (such as the focus on leveraged buyouts) but they differ because they require more credit analysis skills and modeling/transaction knowledge and less ongoing work with portfolio companies.
Not all private equity firms invest in the equity or debt of companies; some also invest in alternative assets, such as real estate, infrastructure (e.g., bridges, toll roads, airports, or power plants), and agriculture.
Even within each of these asset classes, there’s some variation because firms might choose to invest in the equity (e.g. ownership real estate or infrastructure assets) or the debt (e.g. Project Finance, which lends to fund the acquisition and development of infrastructure assets).
Outside of the core asset classes above are even more “exotic” asset classes, such as:
Pension funds and Sovereign Wealth Funds often act as the Limited Partners (LPs) to private equity firms, but over time, many of these funds have formed internal private equity groups.
These groups invest directly in companies, real estate, and infrastructure assets, and often compete with the large private equity firms on deals.
Some firms also exist specifically to invest in private equity funds rather than companies or assets.
They’re called “Private Equity Funds of Funds,” and professionals at these firms spend their time meeting with PE management teams, evaluating firms’ performances, and drilling into the details of how each firm’s portfolio companies have performed.
If the PE fund of funds makes frequent co-investments (e.g., when the PE firm acquires an asset or company, the fund of funds supporting it also chooses to invest extra to fund the deal), then you may get modeling and transaction experience similar to what you would experience at a direct PE fund.
However, most of the work tends to be “higher-level” since you focus on fund-level performance rather than the analysis of specific companies and deals.
You do not necessarily need to raise hundreds of millions or billions of dollars to “be in private equity.”
It’s possible to start with much smaller amounts of capital and focus on acquiring smaller companies.
One popular way to do this is the search fund, where an entrepreneur raises capital, finds a small business, acquires it, runs and improves it, and eventually sells it.
It’s like private equity, but for a single company rather than an entire portfolio of companies.
Many family offices, i.e., the investment arms of high-net-worth and ultra-high-net-worth individuals, have also gotten into the private equity game and formed teams to make direct investments in companies.
We cover these differences in more detail in the articles below: