Equity Insights: What is private equity

The English term "private equity" literally means "private equity" and essentially stands for an investment strategy in which medium to long-term investments are made in unlisted companies with expected high growth potential. These investments are financed via private equity funds set up by private equity companies, which in turn are fuelled by the money raised from investors. Private equity companies are therefore financial intermediaries that help investors (usually large institutional investors) to invest in companies seeking capital.

Where does private equity come from?

The modern forerunners of private equity companies originated in the USA in the 1940s. The first venture capital companies emerged in the USA after the Second World War. The first private equity funds based on today's model then developed in the 1960s.

Why do private equity funds invest in companies?

The aim of investing in companies is to achieve a positive (minimum) return. This is to be achieved by increasing the value of the investment. At the end of the investment period (often between 5 and 7 years) and ideally after the value of the investment has increased, the so-called "exit" takes place. The private equity fund sells the investment in the company via its investment company and the return realised from this is distributed to the investors in the private equity fund. In rare cases, an exit takes place instead of a sale via an IPO.

What is the difference between private equity and venture capital?

Private equity as a generic term also includes venture capital, from which today's private equity model emerged in the 1960s.

Both venture capital companies and private equity companies follow the same basic model. They invest in companies with the aim of increasing the value of the investment and realising this increase in value via an "exit" in the form of a return.

The distinction between private equity and venture capital is therefore essentially based on the strategies with which this objective is pursued.

While private equity companies usually invest in companies that are already established on the market and usually at least in the form of a majority stake, venture capital companies invest in start-ups, i.e. companies that are still in an early development phase. They usually only acquire minority stakes. The investment strategy of private equity companies and venture capital companies therefore differs in particular with regard to the size of the investment and the maturity of the company as an investment object. In the case of venture capital investments, there is a comparatively high risk of total loss of the individual investment due to the early development phase of the target company, which is also expressed by the term "venture capital".

What is the difference between private equity funds and hedge funds?

While private equity funds invest directly in unlisted companies in the medium to long term with a focus on increasing the value of the investment, hedge funds utilise a wide variety of investment strategies. Investment objects are often securities and financial instruments traded on the stock exchange. Even if the name "hedge" suggests otherwise, the investment strategies of hedge funds are comparatively risky, opportunistic and speculative. Hedge funds not only trade in securities traded on the stock exchange, but also speculate with short sales, derivatives and futures transactions.