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Private Equity

Definition - What does Private Equity mean?

Private equity (PE) is a financial buyer that invests in private companies of all sizes. Some private equity firms invest across many industries, while others are focused on specific industries such as technology or energy services. They are a good alternative if you want to sell your company without inflicting severe and immediate change. Private equity firms typically raise funds via general partnerships from institutional-type capital sources such as pension funds, endowment funds, family offices, and high-net-worth individuals.

The typical structure involves a limited partnership (LP), where the PE firm acts as the general partner and the investors are the limited partners. The partnership has a finite term, usually 10 years, at which time the PE firm will sell all of the investments in order to return the original capital plus gains to the limited partners. In addition to capital, PE firms provide other resources such as access to customers, industry expertise, and strategic direction. These resources are often more valuable than capital for company owners looking to grow their companies.

Divestopedia explains Private Equity

PE firms look for companies with solid management teams, recurring customers, high margins, strong balance sheets, and the ability to generate significant free cash flow. The best candidates are private companies that are experiencing rapid growth (organically or through acquisition), a management buyout (MBO), or expansion into a new market. They usually have a leading position in their industry, significant barriers to entry, and a differentiated product or service that commands a valuation premium over the competition.

PE firms are made up of passive investors that expect existing management to run daily operations. However, PE firms may bolster the existing management team by replacing or adding specific positions such as a CFO to manage financial affairs, develop internal controls and standard operating procedures (SOP), and add financial credibility when the firm is looking to exit the investment.

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