Approximately 4,590 private equity firms are headquartered in the United States, and there nearly 2,500 additional firms worldwide. Some firms specialize in a particular investment strategy (such as growth equity, leveraged buyout, distressed buyout, venture capital, and mezzanine fund), while others use some or all these strategies.

Like their venture capital cousins, private equity firms generally find specialties within the industry. Some firms focus on middle-market, mid-cap transactions, while others take aim at overseas purchases (specializing in a particular geographic region such as the Middle East, Sub-Saharan Africa, or Southeast Asia). Still others look at small, public companies or those within a specific sector. Here’s a breakdown of PE investment by industry in 2019, according to the American Investment Council:

1. Business Products and Services: 30 percent
2. Information Technology: 21 percent
3. Healthcare: 15 percent
4. Consumer Products and Services: 14 percent
5. Energy: 12 percent

Then there are the big firms. They have the money and clout to go after the biggest deals in a variety of sectors. These include Apollo Global Management, Blackstone Group, Carlyle Group, KKR, Bain Capital, and TPG.

Firm and Fund Structure

Private equity firms typically consist of:

• Limited partners, which are outside investors who provide the capital. They typically comprise institutional investors (such as pension funds, foundations, banks, endowment funds, and family investment offices), as well as high-net-worth individuals.
• General partners are skilled investors who manage the business and all the parts of the investment cycle.

Most private equity funds are organized as limited liability corporations or limited partnerships and have a finite life span (10 to 12 years). Typical stages of a fund include:

1. Organization/Formation
2. Fund-Raising
3. Deal Sourcing and Investing
4. Portfolio Management
5. Exit

Large private equity firms aim to create multiple, successive funds in order to ensure liquidity and steady profits.

Who Are Private Equity Investors?

The institutions and people who invest in private equity funds are some of the wealthiest in the world. Major pension funds, such as the California Public Employees Retirement System (CalPERS), place some of their money with private equity funds to boost returns. Investment banks with less than $10 billion in assets can place investments in private equity funds (per the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018)—unless, of course, they create their own in-house private equity funds as did Goldman Sachs and Morgan Stanley.

Hedge funds often invest in private equity funds due to the outstanding performance these funds have amassed through the years. Indeed, a few hedge funds have blurred the line between themselves and private equity firms by taking part in public company buyouts either on their own or in partnership with more traditional private equity firms.

And finally, the firms themselves are often heavily invested in their own private equity funds. The private—and, recently, public—companies that manage private equity pools ensure their interests are aligned with those of their investors by placing a large chunk of their own wealth in the mix. This has, of course, resulted in the creation of a breed of private equity deal makers that have joined the billionaires’ club, most famously Henry Kravis at KKR or Steve Schwarzman of Blackstone.

The Role of the Private Equity Firm

These investors don’t want to manage these big-value, big-return investments themselves. Indeed, CalPERS is outstanding at managing money and making sure millions of California retirees get their checks each month, no matter the market conditions. But do they have the expertise to find a good company to buy, run that company, and then bring it public or sell it? That’s where the private equity firms come in.

A private equity firm plays multiple roles throughout a typical investment. For example:

• Raising the fund. The private equity firm serves as a focal point for private capital. The firm raises capital from the various constituencies mentioned above, and then manages that capital appropriately until an investment is identified. In addition, the same people who raise capital also help obtain credit for any leverage needed for a buyout. Finally, they manage payouts to all involved.
• Finding a target. Firms employ researchers whose job it is to analyze the operations of thousands of companies, looking for potential investments. Sometimes it’s easy—many companies readily announce they’re looking at “strategic options,” business-speak for putting themselves up for sale. But there are plenty of opportunities at other companies as well, even ones that seem to be operating just fine. The researchers know the strengths of the private equity firm’s various management teams, and can identify potential targets based on the firm’s ability to generate even more profits from their strengths. And in still other cases, a fund may simply see a very conservative company underutilizing its resources—a chain of casual dining restaurants, for example, that hasn’t leveraged the real estate it owns to the degree it could in order to expand. There are plenty of ways to find a target, which we’ll discuss later on.
• Closing the deal. The fund must then approach the company—or, in some cases, manage a company’s approach to it—and try to make a deal. This is very much like the merger-and-acquisition dance two publicly traded companies might make. The private equity firm generally hires a Wall Street investment bank for its advisory business, though its own cadre of deal-makers and due-diligence teams are often just as talented as those of the advisory firm. A deal is hammered out that usually gives the company’s current shareholders a premium over the stock’s current price, while giving the private equity firm enough room to make an even more impressive profit down the road.
• Running the company. Once a private equity firm buys a company, the deal generally fades from the news, but the hard work is just beginning. The firm, which represents the new owners, has a plan for maximizing profits ready to go—that was part of the targeting and acquisition process. The firm then brings in the individuals it thinks can execute that plan. Such plans often include a wide variety of cost-cutting measures, including new management and production processes as well as layoffs. It also typically includes borrowing quite a bit of money—generally far more than investors in a publicly traded company would stand for. As a rule, private equity firms are aggressive managers, and the leverage is put to work immediately. In recent years, that leverage has also served to give the fund’s investors an early payout—essentially using the company’s good name to sell bonds, the proceeds of which are then distributed to the new owners. One of the biggest debates about private equity is whether debt is justified or even ethical, but when a company goes into private hands, there’s little regulators can do.
• The exit strategy. There are a number of ways to unwind an equity investment and collect the profits. One is to sell the company to another entity, generally to an already-established company that was identified as a possible buyer early on in the due-diligence process. The private equity firm has done all of the hard work, after all, making it more attractive for a major corporation to buy. Alternatively, there are some companies that are simply bought for parts and their assets and property sold off. Finally, and most notably, the private equity firm “flips” the company, returning it to the public equity markets through an initial public offering. In general, the company has to be stronger than it was when purchased for the private equity investors to get a good return, though in some cases— notably the Hertz IPO—the companies can be overloaded with debt. The private investors generally receive the proceeds of the IPO, though in some cases at least part of the proceeds will go to the company itself.