A private equity fund buys control of established companies, usually financing much of the price with debt the company itself must repay.
9 min read · Level 4
The phrase private equity hides the most important word, which is leverage. Once you see a buyout as a loan-financed purchase of one company, most of the asset class's behaviour makes sense - the preference for stable businesses, the sensitivity to interest rates, the occasional sudden total losses. Investors who think of it as a private stock portfolio are usually surprised by exactly those things.
Private equity usually means buyouts: a fund acquires a controlling stake in an established, profitable company, runs it for several years, and sells it. Unlike venture capital, which backs young companies that may not yet make money, buyout funds target businesses with steady cash flow - because that cash flow is what repays the debt used to buy them.
The typical deal structure:
Purchase price (enterprise value) 200,000,000 Debt raised, secured on the company 120,000,000 60% Equity from the fund 80,000,000 40%
The debt sits on the acquired company's balance sheet, not the fund's. The company pays the interest and repays the principal from its own profits. That is the defining feature of a leveraged buyout.
For an investor, the fund structure resembles venture: LPs commit capital, the GP calls it over several years, charges a management fee and takes carried interest, and the fund lasts about 10 years. Access is generally limited to accredited, professional or institutional investors, with large minimums; some listed vehicles, feeder funds and newer semi-liquid products offer smaller entry points, each with its own fees and redemption limits.
There are other strategies under the private equity label - growth equity (minority stakes in growing firms), distressed investing and secondaries - but buyouts make up the bulk of the asset class.
Because the debt changes everything about the risk. A buyout fund's return is not just about whether a company does well; it is about whether the company does well enough to service a large loan. Modest disappointments that a debt-free company would absorb can wipe out the equity in a leveraged one.
It also explains why private equity favours certain businesses: predictable revenue, strong margins, low capital needs. Those are the companies that can carry debt, and they are often mature, which means growth is not the only lever.
And it matters for comparisons. Private equity is often compared to public stocks, but a leveraged position in a smaller company is a riskier thing than an index of large companies, whatever the reported volatility suggests.
This is educational information, not investment, securities or financial advice. Rules differ by country and change — get advice from a qualified professional in your jurisdiction before acting.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Sources: U.S. SEC - Investor.gov; FINRA - investor information; UK FCA - information for consumers
A mid-sized manufacturer, bought by a buyout fund.
EBITDA (profit before interest, tax, depreciation) 20,000,000 Price paid: 10x EBITDA 200,000,000 Debt: 6x EBITDA 120,000,000 Fund equity 80,000,000
At, say, 8% interest, the company now owes 9,600,000 a year in interest before repaying any principal. Its 20,000,000 of EBITDA must cover that interest, taxes, investment in equipment and debt repayment.
The previous owners had no debt. The company's operations did not change on the day of the deal - but its ability to survive a bad year did.
Assuming private equity is simply a private version of the stock market. A buyout is a concentrated, leveraged bet on specific companies, which is a very different risk from owning a diversified index of listed shares.
Confirm whether a fund does buyouts, growth equity, distressed or secondaries. Each has different risks, holding periods and return drivers.
Ask what multiple of EBITDA the fund usually borrows. Higher leverage raises both potential returns and the chance of losing the equity.
Check commitment size, call schedule, fund life and any redemption limits on semi-liquid products before comparing options.
When evaluating any private equity fund, feeder or listed vehicle, or when comparing it to public equity exposure.
When you need liquidity within a decade, do not qualify under local rules, or cannot evaluate managers. Diversified public equities remain the simpler default for most investors.
Buyout debt is often floating rate. When interest rates rose sharply in 2022 and 2023, many leveraged companies saw interest costs increase substantially while their EBITDA did not, squeezing cash flow and pushing some into covenant breaches or restructurings. This was widely reported across financial press and credit rating agency commentary.
Ask whether a fund's companies carry floating-rate debt and how their interest coverage looks if rates rise further.
Create a free account to read the rest and apply it to your own investing.