What Is Private Equity? A Clear Guide to How It Works
By Edoardo Grigione ·
Part of Private equity fundraising library
What is private equity? How private equity firms and funds work, the main strategies, how GPs make money, and how LPs invest, explained simply.
What Is Private Equity? The Short Answer
Private equity is capital invested in companies that are not listed on a public stock exchange. A private equity firm raises money from investors, uses it to buy or take significant stakes in businesses, works to increase their value over several years, and then sells them. The profit from that sale is shared between the investors and the firm.
The term covers both the asset class (private companies owned through funds) and the industry of firms that manage those funds.
How Private Equity Works
Private equity runs on a simple structure with two sides:
- General Partners (GPs): the private equity firm. It raises the fund, selects investments, manages the portfolio companies and decides when to sell.
- Limited Partners (LPs): the investors who supply most of the capital, such as pension funds, insurance companies, endowments, sovereign wealth funds, family offices and funds of funds. Their liability is limited to what they commit.
The typical life of a fund follows four stages:
- Fundraising: the GP collects commitments from LPs. This usually takes 12 to 24 months for an institutional fund. See our private equity fundraising guide for how the process works.
- Investment period: the GP calls committed capital as it finds deals, usually over the first three to five years.
- Value creation: the GP works with company management to grow revenue, improve operations, make add-on acquisitions or restructure the balance sheet.
- Exit and distribution: the GP sells the companies (to a strategic buyer, another fund, or through an IPO) and returns proceeds to LPs.
Most funds are designed to last around ten years, often with extensions.
What Is a Private Equity Firm?
A private equity firm is the investment manager that sponsors and runs private equity funds. It employs investment professionals who source deals, carry out due diligence, negotiate transactions and sit on the boards of portfolio companies. Larger firms also have investor relations teams dedicated to raising capital and reporting to LPs.
A firm usually manages several funds at once, each raised a few years apart (Fund I, Fund II, Fund III). Its track record from earlier funds is the main thing LPs assess when it raises the next one.
Main Types of Private Equity
| Strategy | What it does | Typical target |
|---|---|---|
| Buyout | Acquires a controlling stake, often using debt | Mature, cash-generating companies |
| Growth equity | Minority stake to fund expansion | Profitable or near-profitable growing companies |
| Venture capital | Early-stage minority investments | Startups with high growth potential |
| Secondaries | Buys existing fund interests or portfolios from other investors | Mature fund positions |
| Distressed / special situations | Invests in companies under financial pressure | Turnarounds and restructurings |
| Infrastructure and real assets | Long-term ownership of physical assets | Energy, transport, digital infrastructure |
How Private Equity Firms Make Money
Firms earn in two ways:
- Management fee: an annual fee charged on committed or invested capital, which pays for the team and operations.
- Carried interest: a share of the fund's profits, paid only after LPs have received their capital back plus a minimum return known as the hurdle rate.
Carried interest aligns the firm with its investors: the GP earns most when the fund performs well. Exact terms vary by fund and are negotiated in the Limited Partnership Agreement (LPA).
Private Equity vs Public Markets
- Liquidity: public shares can be sold daily; private equity commitments are locked up for years.
- Control: private equity owners typically take board seats and influence strategy directly.
- Access: investing is mostly limited to institutions and qualified investors, with high minimum commitments.
- Valuation: holdings are valued periodically by the manager rather than priced continuously by the market.
Why Investors Allocate to Private Equity
Institutional investors use private equity to diversify beyond listed stocks and bonds, to access companies that are not available on public markets, and to target long-term returns above public equities in exchange for illiquidity. The trade-off is lower liquidity, higher fees and greater dispersion between the best and worst performing managers, which makes manager selection central to the asset class.
Key Terms to Know
- Commitment: the amount an LP agrees to invest over the fund's life.
- Capital call (drawdown): a GP request for part of the committed capital.
- Dry powder: committed capital not yet invested.
- IRR and TVPI: common performance measures for time-weighted return and total value relative to capital paid in.
- Fund vintage: the year a fund starts investing.
For more definitions, see the RAISE glossary.
Where RAISE Fits
For a private equity firm, the hardest part of the cycle is often the first stage: finding and convincing the right LPs. RAISE is fundraising software for GPs. It helps managers identify institutional investors whose mandates match their strategy, run the investor pipeline, share documents through a secure data room and track every relationship through to commitment.
To go deeper into the fundraising stage, read our private equity fundraising software comparison or learn how private equity firms source LPs.
Frequently Asked Questions
Is private equity the same as venture capital? Venture capital is one type of private equity focused on early-stage companies. The term private equity is often used for buyout and growth strategies specifically.
Who can invest in private equity? Mainly institutional investors and qualified high-net-worth individuals, usually through funds with high minimum commitments.
How long is money tied up in a private equity fund? Typically around ten years, with capital called in stages and returned as investments are sold.