Definition
Private equity is the direct investment of capital into private companies, those not traded on public stock exchanges. Investors commit capital to a fund managed by a general partner (GP) who identifies, acquires, improves, and eventually sells companies for a profit. The three primary strategies are growth equity (investing in expanding businesses), leveraged buyouts (acquiring mature companies using debt), and venture capital (funding early-stage startups).
How It Works
Private equity funds operate on a partnership model. The general partner (GP) manages the fund and makes investment decisions. Limited partners (LPs), the investors, commit capital that is drawn down over 3-5 years as the GP identifies opportunities. The GP then actively manages portfolio companies for 3-7 years before exiting through a sale, IPO, or recapitalization.
The typical fund lifecycle spans 10-12 years. Capital is not invested all at once; the GP issues "capital calls" as deals close. Returns are distributed as portfolio companies are sold. This structure means investors must be comfortable with both the lock-up period and the unpredictable timing of capital calls and distributions.
Fee structures follow the "2 and 20" convention: a 2% annual management fee on committed capital plus 20% of profits above a hurdle rate (carried interest). When all layers are accounted for, total costs can reach 4-5% annually, which means the GP must generate substantial returns before investors see meaningful gains.
The CLERIC framework is essential for evaluating PE opportunities. The Liquidity dimension flags the 7-10 year lock-up. The Experience dimension examines the GP's track record across multiple market cycles. The Cost dimension reveals whether the fee structure is justified by historical performance.
When Entrepreneurs Use This
- Portfolio diversification: As part of the Two Bucket Approach, PE adds return potential to Bucket 2 through a different return driver than public markets
- Leveraging business expertise: Entrepreneurs who have built and sold companies understand private company operations and can better evaluate PE managers and strategies
- Post-exit deployment: After a liquidity event, PE allows participation in private company growth without the demands of running the business directly
- Accessing the billionaire model: PE is a core component of the Billionaire Investment Allocation model, often representing 15-25% of total portfolio allocation in ultra-HNW family offices
- Tax-advantaged returns: Long-term capital gains treatment on carried interest and the ability to defer gains through fund structures
Dew Wealth Perspective
Entrepreneurs have a natural advantage in private equity because they understand how businesses operate, grow, and create value. The risk is that this familiarity breeds overconfidence. An entrepreneur who successfully built a $20M services company may not have the skills to evaluate a $500M leveraged buyout fund.
The Linchpin Partner provides the bridge: access to institutional-quality PE managers vetted through the CLERIC framework, combined with the entrepreneur's own business judgment. Within the Wealth Wheel, the investment advisor coordinates PE allocations with the tax advisor to optimize the timing of capital calls and distributions against the entrepreneur's annual tax picture.