What are private equity firms? (With types and benefits)

By Indeed Editorial Team

Published 20 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Private equity firms consist of a group of investors from a variety of backgrounds that buy private stakes in companies. These firms use their own funds or raise capital from other investors to buy stakes that can help both start-ups or more established companies. Private equity firms don't appear on the stock exchange and are subject to different regulations than firms that do. In this article, we answer the question 'What are private equity firms?', explain what they do and explore what investors consider when assessing companies before they extend offers.

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What are private equity firms?

Private equity firms offer financial assistance to companies, often at a crucial stage of their life cycle. Companies that are in the start-up phase use this financial assistance to grow. More developed companies may also seek investors from private equity firms to help them upgrade their systems and expand their businesses. When private equity firms decide to invest in a company, they can buy either piece of it or the entire business. These firms often buy companies through auctions. In return for their investment, the private equity firm acquires a significant stake in the company.

This allows them to make important decisions about its future. Companies may seek private equity firms that can provide them with industry expertise as well as financial support. Investors that are part of a private equity firm looking for opportunities to increase each company's funds so they can yield a high return on their investment. The firm's members may consist of former CEOs or industry experts. These individuals are responsible for gathering the capital together to make an investment in a company. They also develop investment strategies to fund their acquisitions and ensure that clear guidelines inform their decisions.

Related: How to become a private equity associate: a complete guide

What does a private equity firm do?

The main role of a private equity firm is to inject capital into a company and provide them with business advice. Private equity firms offer finance options to help companies streamline their methods. This can help companies that want to introduce new management systems so they can ensure future growth. When a private equity firm believes it can make a substantial profit, it may choose to sell its shares of a company. Investors may also choose to sell shares of a company if they believe continuing their investment could lead to an increased financial risk.

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Active investors vs. passive investors

An active investor is someone who wants to play a role in the restructuring of a company. They invest both money and time into the companies they work with to ensure the best possible outcome. Passive investors are those who invest in companies purely for financial gains. These investors rarely offer advice to other company leaders and usually don't play a significant role in their decision-making processes. Investors can earn management fees and a percentage of the gross profits when the private equity firm decides to sell a company. They may also receive a return on their investment through:

  • a merger with another company or acquisition

  • an Initial Public Offering (IPO)

  • recapitalisation

How do private equity firms work?

A firm's investors gather funds and then inject capital into companies they believe could be profitable. These firms are often looking for opportunities to invest in a company or start-up that has significant growth potential. When a private equity firm makes an investment, it has a varied list of responsibilities. These can vary depending on the type of investment the private equity firm has agreed to make. Here are some of the responsibilities that private equity firms have:

Raising finance

The firm's investors gather capital from a variety of sources, including their own funds. They may seek to use funds from limited partners or institutional capital like insurance or pensions. They can also seek commitments from external financial institutions.

Sourcing companies to invest in

Firms are looking for opportunities to invest and grow their own funds. They're often looking at areas where they already have the industry knowledge necessary to help streamline and grow a company. When seeking potential investment options, private equity firms look at the following:

  • products or services a company provides

  • industry the company is in

  • the recent performance of the company

  • senior management team

  • valuation of the business

  • potential exit strategy

Private equity firms may leverage their own network, make cold calls or work with other investors to connect with companies that have potential. Active firms often have many connections and strong relationships with professionals from specific industries. This enables them to find opportunities with good potential so they can generate a profit and improve each company's performance. Companies may also seek private equity firms that have strong reputations to ask for investments.

Performing checks and due diligence

Once a firm sources a deal they want to invest in, they perform due diligence to further assess the company's status. What a firm finds during this phase can influence whether they extend a formal offer to the company they're considering. Some of the areas a firm may investigate include the:

  • overall market a company competes in

  • business strategy

  • management team

  • finances

  • business model

  • risks involved in investing

  • exit potential and strategy

Making an offer to a company

After the firm investigates the company thoroughly, they assess whether the company meets the necessary criteria to be eligible for an offer. If the firm determines that investing in the company could yield a high return with a low potential for risk, they meet with their legal team to draft a contract. Then, legal teams from the firm and the company work together to negotiate the final terms. Once both parties agree on, they sign the contract and transfer the equity.

Providing expertise

Since private equity firms consist of experts from different business backgrounds, their insights often increase the growth of the company. They make improvements, cut unnecessary costs and streamline existing systems. They also base their decisions on their stake in the company and their exit strategy to sell the company for a profit after a certain time. Firms with a larger stake in a company may take a more active role in the day-to-day operations of the business. They may have seats on the board or hold leadership positions.

Developing the exit strategy

Making a company or start-up successful is the aim of most private equity firms. They strive to exit their agreement once they've achieved this and then they go on to help another company. Investors aim to exit at a time when the company is growing, so they stand a greater chance of making a profit on their sales. Exit strategies typically occur somewhere between three and seven years after a private equity firm makes the initial investment in a company.


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3 types of private equity firms

There are different ways in which private equity firms prefer to work. These are the most common types of private equity firms:

Venture capital

Seed funding is what venture capitalists provide to start-ups or new companies in upcoming industries. Business strategists in the venture capital area are looking for the potential that already exists in a company so that they can tap into it and grow. Investors are also looking to build companies from the early stages and to gain industry recognition.

Investors look for a seat on the board as part of their investment. They may ask to have a say in how the start-up progresses. While this type of investment can pose risks to the private equity firm, it also comes with significant profits if the investment is successful.

Related: A definitive guide to venture capital careers (with tips)

Leveraged buyout

Private equity firms are always on the lookout for investments that they know they can make a profit from. The leveraged buyout is when a private equity firm buys out a company in its entirety. This allows the investors to take complete control of the company and plan its future based on improvements and making a profit.

This buyout allows the firm to take a company, streamline it and then sell it back to the market with improvements in place. By doing this, the firm puts itself in a position to make huge returns on its investment, since they have total control over when they decide to sell the company.

Growth capital for an existing company

Investors also look for companies that need growth capital to take them to the next level in their business. These companies may decide to bring in a private equity firm that comes with a significant financial investment and industry expertise. This enables the company to develop a strategy for growth by bringing in new systems or streamlining existing ones. It can also help the company expand into a new geographical area or demographic.


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