Private Equity funds invest wholly or mainly in companies that are not traded on a stock exchange. This means that private equity portfolios can be a lot less liquid (harder to turn into cash) than an equivalent equity fund. Some private equity companies invest directly, some make investments in funds (usually limited partnership or LP funds), and some invest in a mixture of the two. Despite the name, some private equity companies invest in forms of debt issued by companies as well as in equity in those companies. A fund that invests directly will usually keep a close eye on its investments, it may put some of its own staff onto the boards of the companies it invests in. Generally there is a lot more work involved in managing a private equity fund than managing a quoted equity fund and so, reasonably, private equity funds tend to charge higher management fees.
The funds invest in companies that are at different stages in their life. Venture funds back new businesses – often these are loss-making in the early part of their life and it may take a long time before these are ready to be sold on. Some funds provide expansion capital – money to help the business grow by investing or by acquiring a competitor. The latter idea is often referred to as buy and build. Most funds invest in Management Buyouts (MBOs) or Leveraged Buyouts (LBOs) – this involves buying some or all of an existing company, often using debt finance, rationalising it – sometimes selling off surplus assets and then using the cash generated by the business to service the debt. Some specialist funds may invest in companies that have run into difficulties – this is known as distressed investing.
The funds look to sell on their investments at a profit – through IPOs or trade sales. They may also just run them for cash they generate – borrowing money and paying it out to themselves as a dividend from time to time.