Private equity: The engine of transformative capital

What is private equity?

Private equity (PE) is a type of investment where firms pool capital from investors to acquire ownership stakes in private companies with the goal of improving operational efficiency, increasing profitability, and ultimately selling at a higher valuation for a profit later. PE is an alternative investment asset class, meaning it's a category of investment that falls outside of traditional investments like public company stocks and bonds. Unlike investing in public stocks, private equity involves taking a hands-on role in the operations of the company it owns, which is known as a portfolio company.

PE-backed companies often deliver faster, more substantial gains than their public or family-owned peers. This investment horizon has been increasing, with PE investors preparing to hold on to their portfolio companies for longer stretches of time, a trend that has contributed to a slowdown in new commitments as fundraising has lagged. This hands-on, long-term approach is different from the more short-term, passive nature of buying and selling stocks in the public market.

What is a private equity firm?

A traditional private equity firm is an investor that raises PE funds to acquire a majority stake in companies. These investors are known for using a large amount of borrowed money to fund the purchase, aggressively increasing revenue and margins, then exiting through a private sale or initial public offering (IPO). This is known as the leveraged buyout (LBO) model described below.

More recently, many PE firms have adopted a growth equity strategy. These investors back late-stage private companies through minority investments, then look to cash in when the startup goes through an IPO or acquisition. For these deals, investors typically use minimal debt or none at all.

This active ownership is what distinguishes the asset class, as modern PE firms focus on learning how to build better businesses to create value, which requires a sophisticated operational backbone. The entity managing the fund uses its expertise to guide the portfolio company toward greater efficiency and growth. This means the firm might bring in new leadership, overhaul a business strategy, or find new ways for the company to make money.

What is a private equity fund?

PE investments are typically made through a dedicated investment vehicle, similar to other private funds, called a private equity fund. Think of a fund as a specific pool of money set aside for a particular investment strategy.

These funds are most commonly organized using a fund structure known as a limited partnership. This is a legal entity that defines the roles and responsibilities of the different parties involved in the fund. This structure allows for a clear separation between the investors who provide the capital and the managers who deploy it. The rules governing this relationship are detailed in a legal document known as the limited partnership agreement (LPA).

The roles of general partners and limited partners

The limited partnership structure involves two main parties: general partners and limited partners. Each plays a distinct and important role in the fund's success, with a clear division of labor and responsibility.

• General partners (GP): These are the investment professionals at the PE firm. They are the active managers responsible for the entire investment process. This includes raising the fund, sourcing and evaluating investment opportunities, managing the portfolio companies through portfolio monitoring after the acquisition, ongoing asset management, and executing the final sale or exit.

• Limited partners (LP): These are the passive investors who commit capital to the fund. LPs are typically institutional investors—such as pension funds, university endowments, and insurance companies—as well as high-net-worth individual investors and family offices. They entrust their capital to the GP's expertise and do not participate in the day-to-day fund management.

The fund lifecycle: From formation to exit

A PE fund has a finite life, typically structured with a 10-year fund term. This lifecycle is broken down into several distinct phases, each with its own set of objectives and activities that guide the GP's actions.

• Fundraising: The GP markets the fund to potential LPs, securing capital commitments that will be drawn down via a capital call over time to make investments. This phase involves creating a pitch, negotiating terms, and legally closing investors into the fund.

• Investing: The GP identifies and manages deal flow to perform due diligence on target companies, then deploys the committed capital to acquire them. This is often referred to as the investment period, which typically lasts for the first few years of the fund's life.

• Value creation: The GP uses portfolio management to work closely with the management of its portfolio companies to implement strategic initiatives, grow the business, and improve operational performance. This is the hands-on phase where the firm's expertise is put to work.

• Exit: The GP seeks to sell its stake in the portfolio companies to realize a profit. Common exit strategies include a sale to another company (a strategic acquisition), a sale to another PE firm (a secondary buyout), or an IPO. Of these paths, mergers and acquisitions (M&A) is a much more frequent outcome than going public. For example, while startup M&A activity on Carta accounted for 647 deals in 2022, there were just 181 total U.S. IPOs in the same year.

• Distribution: The GP returns the initial capital and any profits to the LPs as a distribution, concluding the fund's lifecycle. In a positive sign for investors, recent data shows that sponsor distributions to LPs exceeded capital contributions for the first time since 2015. This process, often called the distribution waterfall, ensures LPs are paid back before the GP receives its share of the profits.

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Types of private equity investments

The term "private equity" is an umbrella that covers several different investment strategies. The strategies a PE firm chooses dictate the type of companies it targets, the amount of capital it deploys, and the methods it uses to generate returns. Understanding these strategies helps you see the diversity within the asset class.

Leveraged buyout

Leveraged buyouts (LBO) are the most common PE investment strategy. In an LBO, the PE firm acquires a majority stake in the company, using equity and a large amount of debt that goes onto the company’s balance sheet. The portfolio company is then responsible for paying back that debt through cash resulting from the operational improvements made during the PE firm’s ownership tenure.

Growth equity

PE firms that specialize in growth equity investments purchase a minority stake in mature companies that are growing revenue but are perhaps not yet profitable. The goal is to help the company fund a specific expansion project, enter a new market, or launch a new product without the founders giving up control of their business.

Growth equity and late-stage venture capital (VC) are often used interchangeably, but they have several key differences. Growth equity and VC deals differ by investment sizes, revenue goals, target industries, and investment geographies.

For example, middle-market PE firm Kayne Anderson uses a growth capital strategy as one of its primary approaches. As its portfolio companies scale, they rely on platforms like Carta to help manage their equity professionally and provide clear visibility to their investors.

Venture capital

Venture capital (VC) is technically a form of PE, but it is distinct enough that it's often considered its own asset class. VC focuses on funding early-stage startups with high growth potential. This involves a different risk and return profile compared to traditional PE, which targets more mature and stable businesses. Venture capitalists operate on a high-risk, high-reward model, fully expecting that many of their portfolio companies will fail.

VCs take on this risk because the few investments that succeed can generate substantial returns, with the top decile of funds from the 2017 vintage achieving returns of more than 3.5 times their investors’ paid-in capital—a threshold widely considered to be a sign of exemplary performance. VC firms invest for the long-term, with fund lifecycles often lasting up to 10 years.

Private equity vs. venture capital

While both PE and VC operate in the private markets, they target different types of companies and employ different strategies. Understanding these distinctions is key to understanding the broader private investment landscape. A table is often the clearest way to see these differences side-by-side.

In essence, PE often acts like a business operator, buying established companies and working to make them more efficient and profitable. VC, on the other hand, acts more like a talent scout, identifying promising young companies and providing the fuel they need for rapid growth.

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Other strategies: Secondaries, distressed debt, and fund of funds

Beyond the main categories, PE firms employ other specialized strategies to find unique opportunities and generate returns. These niches require specific expertise and offer different risk-reward profiles.

• Secondaries: This strategy involves purchasing existing stakes via secondary market transactions in PE funds or direct ownership in companies from other investors who are looking for early liquidity. It allows new investors to enter an investment at a more mature stage.

• Distressed debt: This involves private credit investing in the debt of companies that are in financial trouble. The goal is often to gain control of the company during a restructuring process and turn it around, potentially converting the debt to equity.

• Fund of funds: In this model, or via co-investment, a fund invests in a portfolio of other funds rather than directly in companies. This offers LPs diversification across multiple managers, strategies, and vintage years with a single investment.

Other forms of PE, including mezzanine investing, real estate investing, and more.

How private equity firms create value

The perception of PE has evolved from a focus on financial engineering—which historically drove roughly two-thirds of the total return for many buyout deals through leverage and multiple expansion—to a more hands-on, operational approach. Modern PE firms act as strategic partners, working to build stronger, more resilient businesses through a variety of methods.

Through operational improvements

Today's PE firms bring deep industry and functional expertise to their portfolio companies. Their operating partners work directly with management teams on specific initiatives to improve the business from the inside out.

Common operational improvements include:

• Optimizing pricing strategies to better capture market value

• Improving sales and marketing effectiveness to accelerate growth

• Executing strategic add-on acquisitions requiring purchase price allocation (PPA) to expand market share or enter new product lines

• Streamlining supply chains and internal processes to reduce costs

Through broad-based employee ownership

An innovative and increasingly important value creation lever is extending equity compensation to portfolio companies’ employees. This shift toward broad-based ownership is becoming more prevalent in the PE community, where the practice was once reserved for management. Data on PE trends shows that the percentage of PE-backed LLCs issuing equity to non-management employees grew from 25% in 2021 to 36% in 2023.

As Shiv Narayanan, founder of the How to SaaS podcast, explains during Carta’s Value Creation through Employee Equity webinar: "Whatever value creation plan you build, the main point of failure is if you have the right people... that is the X factor in being able to succeed with their value creation plans."

When employees have a stake in the outcome, it can boost morale, drive performance, and improve employee retention. The structure of equity grants, for example, is effective for retaining talent over the long term. Data on startup job tenure shows a strong correlation between employee departure patterns and the four-year vesting schedules common to most equity plans, suggesting that the promise of full ownership is a key factor in an employee's decision to stay.

For example, after receiving a minority investment from PE firm Bain Capital, professional services firm Sikich leveraged Carta to power its employee ownership expansion, often using profits interest for LLC structures. This move was a core part of its strategy to drive acquisitions and evolve its approach to talent retention.

How do private equity firms make money?

PE firms charge investors an annual management fee and earn carried interest—a share of the fund’s profits. This compensation model is often called “two-and-20.” It consists of a median management fee of 2% during the investment period and the GP taking 20% of a fund’s profits in carried interest. PE firms also make money through dividend recaps, which are slightly more controversial than simply earning carry or charging LPs to manage their capital.

• Carried interest: This is the profit paid to a fund’s GPs. Typically, PE fund managers receive 20% of their portfolio company’s profit after they hit the hurdle rate—the amount that goes back to LPs—described in the LPA. PE fund managers do not receive any of the carried interest profits until their LPs see their capital returned first. Carried interest is taxed as capital gains instead of income.

• Management fee: This is the fee that GPs charge their own investors (LPs) to manage their money. Typically, GPs will wait until they are ready to make an investment before calling committed capital, thus limiting the LP’s cost burden and boosting PE firm’s internal rate of return (IRR), a time-based formula that represents the money returned to LPs. Management fees are taxed as normal income.

• Dividend recapitalizations: In a dividend recap, a PE firm essentially pays itself back for their original capital investment by taking out a loan against the portfolio company in which it invested. This allows PE firms to nearly eliminate their downside risk while the portfolio company is tasked with improving operations through either revenue growth or kickbacks. In 2017, lawmakers banned dividend recaps within the first two years of a firm owning a company.

The private equity industry and market outlook

The global PE industry is undergoing significant transformation amidst evolving market dynamics. Throughout 2023 and into early 2024, deal-making activity within PE faced headwinds due to higher interest rates, tightened credit conditions, and ongoing macroeconomic uncertainty. Valuations, particularly in the growth and late-stage venture segments, have compressed, shifting negotiation power toward buyers and leading to more structured deals and investor protections. PE firms are responding with increased creativity in deal structure and a notable focus on operational improvements to create value, rather than relying primarily on multiple expansion or aggressive leverage.

Market trends show a growing interest in secondary transactions, as both founders and early-stage investors seek liquidity in today’s slower IPO and exit environment. This has driven dynamic growth in the secondary market, with Carta data showing that private market secondary transaction volumes reached a record high of $160 billion in 2024, representing a 41% year-over-year increase, even as overall exit activity remains muted.

Trends also show expanding sector diversity and prolonged private company timelines, with PE firms investing in a broader array of sectors. As these trends unfold, scrutiny around due diligence, governance, and alignment of interests between LPs and GPs is intensifying, further shaping the evolution of PE deal-making.

→ Learn more: Download our latest private equity report

How to invest in private equity

Direct investment in PE is generally limited to accredited investors and institutions. For an LP, the process begins with reviewing a fund's offering documents and conducting due diligence on the GP. If you decide to invest, you sign a subscription agreement to commit capital and complete the necessary compliance checks.

A special purpose vehicle (SPV) is a legal entity that allows a group of investors to pool their capital for a single investment, such as in one specific company. As the team at High Circle Ventures found, using Carta SPVs was an effective way to build an investment track record before launching a full-scale venture firm.

Building an institutional-grade back office for private equity

The complexity of the PE lifecycle and the demands of investors mean that modern, integrated fund management software is essential for success. Fund professionals have been historically underserved by legacy software and manual processes, forcing them to piece together solutions that don’t scale.

Fund administration should be a strategic as well as operational function. A strong back office will provide the data and insights that help GPs make better investment decisions and raise their next fund more easily.

For an established firm like Kayne Anderson, which manages a complex portfolio with billions in assets, having a modern infrastructure is critical. It demonstrates that top firms rely on integrated technology to maintain their edge and deliver for their investors. This allows them to elevate their role from back-office administration to strategic partners who drive fund performance.

Request a demo to see how a unified platform can help you build an institutional-grade back office for your PE firm.

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Frequently asked questions about private equity

What is the difference between a private equity firm and a private equity fund?

A PE firm is the management company that employs the investment professionals. A PE fund is the specific pool of capital raised by that firm for a set period to make investments.

What are the risks of investing in private equity?

The primary risks for investors are illiquidity, as capital is locked up for many years, and the potential for capital loss if the fund performance does not meet expectations.

What are the main types of private equity strategies?

The primary strategies include a leveraged buyout, which involves acquiring a company using a significant amount of borrowed money. Another isgrowth equity, which focuses on minority investments in mature companies to help them expand. VC is also a form of PE that provides funding to early-stage startups with high growth potential.

How do private equity firms create value in their companies?

Value creation has evolved from primarily using financial engineering, like private credit investing, to focusing on hands-on operational improvements. This includes increasing a company's revenue, improving its profit margins, and implementing strategic initiatives to foster long-term growth.

Who are the largest private equity firms in the market?

While firms like Blackstone, KKR, and The Carlyle Group are among the most well-known, the modern PE market is defined by more than just size. A firm's operational sophistication and technology stack are just as important to its success as its track record and assets under management.

What is the difference between a private equity fund and a hedge fund?

The primary difference is their investment horizon and liquidity. PE transactions are typically long-term, illiquid investments to own and operate companies, while hedge funds typically trade more liquid securities with shorter time horizons and more complex strategies.