What Is a Private Equity Firm? How PE Firms Work

Short answer: A private equity firm is an investment manager that raises money from investors into private funds and uses it to buy stakes in private companies, often taking control. It aims to improve those companies and sell them later at a profit. The firm earns management fees on the capital it manages and carried interest on the profits.

The term covers a wide range, from global buyout managers to two-person firms buying small businesses. The underlying model is the same: raise a fund, invest it, add value, exit, return capital and raise the next fund.

How private equity firms are structured

A PE "firm" is usually a group of related entities rather than one company.

A firm that has raised several funds will have a separate GP and fund vehicle for each one, all served by the same management company. That separation keeps each fund's investors, economics and track record distinct.

Inside the management company, a typical hierarchy runs from analysts and associates to vice presidents, principals and partners or managing directors, with investor relations, finance and operations teams alongside.

How private equity firms raise money

Private equity firms raise capital from limited partners. Common LPs include public and corporate pension plans, university endowments, foundations, sovereign wealth funds, insurance companies, funds of funds, family offices and high-net-worth individuals.

The process for each fund:

1. Prepare materials. A private placement memorandum, track record, strategy deck and data room.

2. Market to LPs. Meetings, diligence questionnaires and site visits, sometimes with a placement agent.

3. Negotiate terms. Fees, carry, preferred return, key person provisions and side letters.

4. Hold closings. A first close lets the fund start investing; later closes admit more LPs.

5. Call capital. LPs fund commitments over time as the firm makes investments.

Raising a first fund is the hardest step. Many emerging managers begin with deal-by-deal SPVs to build a record before raising a blind-pool fund.

How private equity firms find and buy companies

• Sourcing. Relationships with investment banks, business brokers, founders and other investors; proprietary outreach to owners.

• Screening. Filtering against the fund's strategy on sector, size, geography and growth.

• Diligence. Financial, commercial, legal and operational review, often with outside advisers.

• Structuring. Buyouts commonly combine fund equity with debt; minority growth deals use less or no debt.

• Closing. Signing the purchase agreement, arranging financing and taking board seats.

How private equity firms add value

Once a company is acquired, the firm works with management to grow profit. Common levers include:

• Professionalizing finance, reporting and governance

• Pricing and sales improvements

• Add-on acquisitions to build scale

• Cost discipline and operational efficiency

• Recruiting or replacing executives

Holding periods often run several years before an exit through a sale to a strategic buyer, a sale to another PE firm, an IPO or a recapitalization.

How private equity firms make money

Management fees. Charged annually to the fund, commonly as a percentage of committed capital during the investment period and of invested capital afterward. Fees pay for the team and operations.

Carried interest. The firm's share of fund profits, paid after LPs receive their capital back and usually a preferred return. Carry is the main source of wealth creation for partners and ties their pay to results.

Other fees. Some firms charge portfolio companies transaction or monitoring fees. Modern LPAs often require these to offset management fees, and LPs scrutinize them closely.

GP commitment returns. Partners invest their own capital in the fund and earn returns on it like any LP.

Types of private equity firms

How private equity firms operate day to day

Beyond deals, the firm runs a regulated asset-management business: calling capital, sending distributions, maintaining capital accounts, producing quarterly reports and audited financials, handling securities filings and managing conflicts. Many outsource these functions to a fund administrator so the team can focus on investing.

Private equity firm vs hedge fund vs investment bank

These three are often confused. A private equity firm buys and holds ownership in private companies for years through closed-end funds. An investment bank advises on deals and raises capital for clients, earning advisory and underwriting fees rather than owning companies long term. Hedge funds, outside the scope of this guide, generally trade more liquid securities with different fund terms. Private equity firms frequently work with investment banks on both sides of transactions: banks run sale processes that PE firms bid in, and banks arrange the debt financing used in buyouts.

How long a private equity firm holds a company

There is no fixed rule. Holding periods depend on the business plan, market conditions and the fund's remaining life. A firm may sell early if an attractive offer arrives, or hold longer and use a continuation vehicle if it believes more value can be created.

Where Allocations fits

Allocations helps new and growing private equity managers form funds and deal-by-deal SPVs, onboard investors and run ongoing fund administration. See pricing.

Related: How to start a private equity firm, What Is a General Partner?, J-curve in private equity.

Starting a PE fund or co-invest SPV? Allocations handles SPV and fund formation, investor onboarding and fund administration. See how Allocations SPVs work or compare pricing.

More on this topic

• Dry powder in private equity

Key takeaways

• A private equity firm raises funds from LPs and uses them to buy and improve companies.

• Firms earn management fees and carried interest, usually through a GP entity and a management company.

• Typical holds run several years before an exit through a sale, recap or IPO.

• PE firms differ from hedge funds (liquid trading) and investment banks (advisory).

Frequently asked questions

What is a private equity firm in simple terms?

A firm that raises money from investors into private funds and uses it to buy and improve private companies, aiming to sell them later for more than it paid.

How do private equity firms make money?

Mainly through management fees on the capital they manage and carried interest, a share of profits paid after investors get their capital back and any preferred return.

How are private equity firms structured?

Usually as a management company that employs the team, a general partner entity for each fund, and fund vehicles, typically limited partnerships, in which investors hold LP interests.

How do private equity firms raise money?

They raise funds from limited partners such as pensions, endowments, insurers, family offices and wealthy individuals, who commit capital that is called over the fund's life.

How do private equity firms work with companies they buy?

They take board seats, set strategy with management, fund add-on acquisitions, improve operations and reporting, then exit through a sale or IPO.

What is the difference between private equity and venture capital?

Venture capital backs early-stage startups with minority stakes, while private equity usually buys larger, established companies, often taking control and using debt.