Types of Private Equity Funds

What are the different types of private equity funds out there? “Private equity” is a generic term used to identify a family of alternative investing methods; it can include leveraged buyout funds, growth equity funds, venture capital funds, certain real estate investment funds, special debt funds (mezz, distressed, etc), and other types of special situations funds.

Funds can specialize in particular industries or be industry-agnostic, and they can focus on particular geographies as well. Let’s dig a little deeper into the most common types of private equity funds.

  • Leveraged buyout funds typically acquire controlling stakes, either alone or in partnership with other PE firms, of mature, cash-flow-stable companies. To finance these transactions, they will use a combination of debt (in the form of bank and term loans and subordinated or mezzanine debt) and equity capital (from the GP and LPs). That means PE firms buy companies using a little bit of their own money, and a lot of borrowed money—similar to the way homeowners take out a mortgage to buy a house, using only a little bit of their own money while borrowing the rest. In return for loaning the PE firm money to finance a buyout transaction, the PE firm collateralizes the debt using hard assets and cash flow / working capital pledges of the company, allowing the lenders seniority in the event of a bankruptcy liquidation. In the “go-go” years of private equity, the debt portion of a transaction would account for as much as 85% or more of the total purchase price, and would sometimes even exceed 90%. Post-financial crisis, however, these amounts have declined to saner levels. (When I was working in PE, we did our deals typically with the expectation of 50% debt financing and 50% equity financing.) In order to create value, PE firms typically depend on a combination of techniques, including cutting costs and CapEx to expand profitability, streamlining working capital, striking new partnerships to open new customer channels (and new revenue sources), buying related companies and combining them together (called “tuck-in” acquisitions)—along with straight up financial engineering and multiple arbitrage (which don’t really increase value but rather transfer it). Examples of LBO firms include: KKR, Carlyle, TPG, Blackstone, and Apollo.
  • Venture capital funds usually invest in minority stakes in startup companies, often in high-growth sectors like internet and consumer technology, bio-tech and healthcare technology, and energy. These days, VC firms basically come in two flavors—very early stage vs. later stage funds. They typically do not invest based on cash flow modeling (as PE firms do). Instead, “early” stage funds typically invest in companies that have raw technical talent to invent and commercialize new technologies; they help fund them to show proof of concept, feasibility, and consumer desirability. “Later” stage funds invest in companies that have largely demonstrated these things already, and are looking to scale operations to true viability. Their strategies generally involve helping portfolio companies maximize their growth potential by introducing them to new customers and partners, helping them recruit world-class engineering, technical, and managerial talent, and coaching them on how to expand and professionalize various corporate functions (e.g., finance, marketing, sales, HR, legal). Examples here include Kleiner Perkins, Sequoia, Accel, August Capital, and Andreessen Horowitz.
  • Growth equity funds invest in more mature businesses that are looking to scale operations (organically or through M&A) and enter new markets. They invest more broadly than VC funds in terms of industries, and I would say they are somewhat more agnostic about whether the target industry is “high growth” (compared to VC funds). They sit a little ambiguously between pure-play LBO funds and “later” stage VC funds. Sometimes, VC or PE funds will have growth equity divisions, which also blurs the line even further. You can think of growth equity funds as “bridge” funds between VC and PE. Examples here include: Summit Partners, JMI, and TA Associates.

 

Be sure to check out our PDF guide “How to Nail Your Private Equity Interview (whether you have finance training or not)” for in-depth tips and strategies on how to successfully interview for jobs at top private equity firms!

Also be sure to check out our step-by-step Private Equity LBO Modeling Training Videos for walk-through tutorials on how to build an LBO model, navigate Excel with ruthless efficiency, and rapidly create an LBO PowerPoint deck to present to your PE interviewers.

Andrew Chen

Andrew Chen received an associate offer, without any formal LBO experience, on his first attempt at applying for private equity investing positions in the competitive San Francisco Bay Area. He worked for Huntsman Gay Global Capital, the Bain Capital spin-out founded by the industrialist Jon Huntsman, former Bain Capital Chairman Bob Gay, former San Francisco 49ers Superbowl quarterback Steve Young, and including former CFO of Citigroup and American Express Gary Crittenden. Andrew was previously a member of the Corporate Finance & Strategy Practice at McKinsey & Company and holds a J.D. from Harvard Law School. You can follow him on Twitter and .

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