What is private equity? Understanding the basics
Learn the basics of private equity investing, and discover the benefits and how to get started.
Private equity investment is a vast and wide-reaching form of investment that can potentially generate high returns for investors whilst also being capable of more resilience than many other types of investment in periods of market stress. In this article, we'll explain the basics of private equity investing and give you all the information you could need to get started.
What is private equity?
For investors new to private markets, there can be confusion as to what private equity investment actually is, with potential investors asking about the difference between private equity vs venture capital or how hedge funds differ from private equity funds.
Private equity investing refers to the investment of capital into companies and organisations that are not publicly traded (on the stock market) and are open to being bought out entirely or receiving significant private investment in exchange for equity.
Private equity investments can be made directly into single companies (for example, to support a management buyout or in the form of growth equity) or through funds operated by professional managers. Private equity funds will typically raise capital and then deploy that capital into a range of different companies over a period of time; for example, two years. This aims to create a diverse portfolio by spreading sources of risk and return across different underlying companies and also adds temporal diversification.
How does private equity differ from public equity?
The key differences between public and private equity lie in liquidity, transparency, and management influence. Public equity trades on stock exchanges with continuous pricing and instant transactions, while private equity locks up capital for extended periods, allowing managers to pursue long-term strategies without the pressure of quarterly earnings or share price volatility.
Private equity investors often gain board representation and information rights, enabling closer oversight and faster strategic decisions, and valuations are performed quarterly using methods like discounted cash flows or comparable transactions, unlike the continuous market pricing of public companies. For a more detailed comparison of these market structures, see our guide on private vs public markets.
What are the different types of private equity?
Depending on the stage of a company’s growth or the specific use for the capital being raised, you may encounter different terms used to describe an investment opportunity or a transaction in a private company.
Venture capital
Perhaps the most commonly known branch of private company investment, venture capital is a term that's commonly used to describe an equity investment into a smaller, emerging company which has the potential for sizeable growth. This is often in industries that are still relatively young and ripe for development or where the company’s products or services have the potential for global application. Examples of this include deeptech, fintech or ‘Internet of things’ (IOT) companies. The company may not yet be profitable or may be re-investing all profits for growth.
Private equity funds that specialise in venture capital investment seek to identify companies that have the potential to generate sizeable returns, but which require capital to achieve that growth. Private equity funds will take a significant stake in the company and aim to help it reach its potential.
When venture capital funding is received by a company, it will invest all of the capital into the company and use it to expand its operations in a short timeframe. The intention of this funding is to transform the company into an industry-leading powerhouse, whilst adding value by upskilling the internal team to help ensure long-term success and stability.
Growth equity
While venture capital identifies companies that are yet to scale up, growth equity targets more established and mature companies that need capital. These companies also need the support that professional investment brings in order to grow to the next level.
Growth equity investments are often sought by companies that require additional capital in order to facilitate this period of growth. In these cases, if the business can make the necessary changes and expand, there's a strong possibility that revenue and profitability will increase substantially. Consequently, the value of the company can increase, which is a key factor in a private equity investor’s ability to generate returns on an investment on exit.
Although still risky, investments in more mature companies are seen as lower risk than venture stage companies, as they already often have a good level of established revenue and profit.
Buyouts and leveraged buyouts
A buyout is where a controlling stake in a company is purchased from previous shareholders. This acquisition may be organised by a management team already in place at a company, who may be wishing to take a company on from the original founders. It may also be a new management team organised by a private equity firm which has purchased an interest in the company.
Some buyouts are leveraged, which means the private equity firm will use debt to complete the purchase and use the company's assets as collateral.
When a company is going through a period of decline or stagnation, the opportunity for it to be bought out may be appealing for some private equity funds, especially if the company is fundamentally strong but experiencing temporary problems. The reasons for this stagnation may not be down to anything being inherently wrong with the company. It may be a symptom of there not being enough capital available to help take it to the next level.
In a leveraged buyout, the private equity investment capital is used to pay a small fraction of the agreed purchase price, with the rest being collateralised using the target company's assets and internal value. This means that firms can buy out companies that would otherwise be unattainable using a smaller amount of upfront capital. This can open the doors to additional, industry-specific investment later down the line.
At Connection Capital, we provide financing for management buyouts to UK SMEs, creating access to direct private equity transactions for our clients. We also offer a range of private equity funds operating buyout, growth and venture strategies.
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The role of private equity in the investment landscape
Supporting business growth and innovation
Private equity plays a crucial role in funding innovation across the economy. Venture capital, a subset of private equity, has backed many of the world's most transformative companies during their early years. These investments provide patient capital that allows businesses to develop products and build markets before achieving profitability.
Beyond technology, private equity supports innovation in traditional industries. A food manufacturer investing in sustainable packaging or a logistics company adopting automation both require significant upfront investment that private equity can provide. The ability to fund transformation across diverse industries makes it an important catalyst of economic development.
The active ownership model accelerates growth in ways that passive investment cannot. Private equity firms typically bring operational expertise, strategic networks, and governance improvements to companies they invest in. Management teams of these portfolio companies gain access to best practices from other investments and benefit from the collective experience of their investors.
Private equity vs other asset classes (public markets, bonds, private debt)
Understanding how private equity works can be assisted by comparing it to alternative investment options. Public equities offer liquidity and transparency but expose investors to market volatility and limit their influence over company decisions. Private equity sacrifices liquidity in exchange for active control and potentially enhanced returns.
Bonds and other fixed income investments provide regular income and capital preservation but typically deliver lower returns than equity investments. Private debt occupies a middle ground, targeting fixed returns with some downside protection through security over company assets, though without the ‘full fat’ upside potential of equity ownership.
Public markets have become increasingly short-term focused, with average holding periods measured in months rather than years. Private equity's longer investment horizons enable strategies that public market investors would struggle to implement, such as complex operational restructurings or multi-year research and development programmes.
How private equity fits into a diversified portfolio
Sophisticated investors tend to use private equity to complement traditional holdings rather than replace them. The asset class provides diversification benefits because private equity returns show lower correlation with public market movements.
Portfolio construction typically involves allocating a proportion of overall wealth to alternative asset classes, including private equity, with the target percentage depending on individual circumstances, risk tolerance, and liquidity needs. Many institutional investors, which have long-term investment horizons target allocations of up to 30 per cent to private markets.
The illiquid nature of private equity means investors must carefully consider their liquidity requirements before committing capital. Most private market funds draw capital over several years and return it gradually as investments exit, creating a distinctive cashflow profile (the ‘J-curve’) that requires planning.
Private equity can also provide access to sectors and opportunities unavailable in public markets. Many innovative companies now remain private longer than previous generations did, meaning public market investors risk missing significant value creation periods. Access to private markets enables participation in this growth.
How does private equity create value?
Private equity firms undertake a vast amount of due diligence before completing any deal and will look at a number of factors before deciding whether to invest in a company. The underlying figures and investment case must demonstrate to investors that the company has the potential to realise the target return.
When we look at how private equity investors create value, we should look at why companies look for this type of investment. Companies who seek this form of investment often require capital in order to facilitate a period of growth to maximise profitability and open them up to new markets and audiences.
This is how private equity creates value — it enables companies to make the necessary changes that will increase revenue and profits. That is rarely just through the provision of capital alone. Professional investors are able to draw on past experiences of working with private companies, as well as networks of specialists who can help improve various aspects of a business, from strengthening management to entering new markets, planning acquisitions, through to, eventually, preparing for an exit.
Benefits of private equity investment
Private equity firms are able to support companies to achieve their growth plans through the supply of capital. Private individuals or organisations investing in private equity may enjoy various benefits to their investment portfolio such as portfolio diversification and outperformance versus other asset classes.
Who typically invests in private equity?
Institutional investors
Pension funds represent the largest category of private equity investors, allocating to the asset class to generate returns that support future liabilities. These institutions typically have long investment horizons matching private equity's illiquid nature and can commit substantial capital across multiple fund vintages.
Insurance companies invest in private equity to diversify portfolios beyond fixed income holdings and generate returns that improve their ability to meet policyholder obligations. Regulatory capital requirements influence their allocation decisions and preferred risk profiles.
Endowments and foundations pioneered private equity adoption among institutional investors, with university endowments particularly active in alternatives. Their permanent capital bases and long-time horizons suit the illiquid nature of private equity investments.
Sovereign wealth funds have become significant private equity investors, deploying national savings to generate returns and diversify away from concentrated resource or export exposures. These institutions often commit capital directly to companies alongside fund investments.
High-net-worth and sophisticated investors
Family offices managing wealth for ultra-high-net-worth families increasingly allocate to private equity. These investors seek diversification, tax efficiency, and returns exceeding public markets. Their permanent capital and long-term perspectives align well with private equity characteristics.
Sophisticated individual investors can also now increasingly access private markets through various structures. These including single-asset direct investments or co-investment opportunities, and funds which pool capital and provide diversification across underlying assets.
Qualification requirements typically restrict private equity access to investors meeting financial thresholds and demonstrating relevant investment experience and knowledge. These requirements reflect the complexity and risks associated with illiquid alternative investments.
Why access for private investors is expanding?
Regulatory changes and product innovation have broadened private equity access beyond traditional institutional investors. New structures enable smaller commitments and provide greater liquidity than traditional fund formats offered.
Technology platforms have reduced operational costs associated with managing larger numbers of smaller investors. Digital infrastructure enables private equity managers to serve mass affluent segments that were previously uneconomical.
Secondary markets have developed where investors can trade private equity stakes before funds complete their investment cycles. Whilst liquidity remains limited compared to public markets, these markets provide more flexibility than traditional structures allowed.
Growing recognition that private equity represents an important asset class has prompted investment platforms and wealth managers to develop products bringing private market opportunities to broader investor bases. This democratisation trend seems likely to continue as technology and regulation evolve.
We hope this article has helped you understand the basics of private equity. If you’re interested in exploring further, and want to learn how to invest, get in touch with a member of the Connection Capital team, and we’d be happy to explore your options.
Please note:
Past performance is not a reliable indicator of future performance. Investments in private equity are high risk and speculative which means there is no guarantee of returns and investors should not invest unless they are prepared to lose all of their money. This type of investment is illiquid so can’t be easily accessed until the exit point. The investor is unlikely to be protected if something goes wrong.
