Private Equity 101: What Founders Need to Know Now

Charlotte Ellis

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Everything you need to know about private equity

If you’re not familiar with private equity (PE), it can seem like an exclusive, high-stakes world. But first-time founders can quickly come to terms with it and harness its growth and value creation opportunities.

All it takes is a little understanding of its mechanics…

What is Private Equity?

At its core, PE involves investment firms pooling capital from limited partners (LPs) such as pension funds, insurance companies, or wealthy individuals. This capital is then deployed into private companies (or assets), often in exchange for equity. PE firms (now the ‘sponsor’) would aim to grow these companies within their portfolio and sell them at a profit within 5-7 years.

However, the market dynamics of PE have shifted, presenting both challenges and opportunities. Currently, PE is going through one of its most complex periods – shaped by economic pressures, high interest rates, a record level of cash to invest, and a backlog of unsold assets. This context is driving both sponsors and owners to innovate and refine their strategies.

The state of Private Equity in 2024/5

The PE industry is grappling with several interconnected challenges:

Cash flow pressures

LPs are experiencing slower returns. This cash flow strain reduces their ability to reinvest, creating a bottleneck in the funding ecosystem.

The dry powder dilemma

Despite record dry powder (uninvested capital) of $1.2 trillion, 26% of it is over four years old. This creates immense pressure on general partners (GPs, those that operate the fund) to deploy capital (fund new investments) effectively.

Interest rate headwinds

Rising interest rates over the past two years have increased borrowing costs, reducing the leverage that PE firms can use to acquire businesses and drive down valuations. This has led to fewer deals, with PE firms exercising caution due to limited debt financing availability.

Extended holding periods

Historically, PE firms held assets for 3-5 years. Today, holding periods have stretched to 5-7 years, showing just how difficult it is to exit investments right now.

The outlook for 2025 and beyond🔗

While there are plenty of challenges, there’s also optimism and innovation in the market:🔗

Deal activity resurgence – With interest rates likely to moderate to a ‘soft landing’, PE firms are gearing up for increased deal-making over the coming years. Even a slight drop in rates could unlock new opportunities.
Greater focus on value creation – To counter market headwinds, PE firms are prioritising operational improvements like pricing strategies, sales effectiveness, and product innovation to drive growth in earnings before interest, taxes, depreciation, and amortisation (EBITDA).
Innovative liquidity solutions – Secondary markets and creative refinancing tools, such as continuation funds, are helping GPs manage the backlog of unsold assets.

What the industry’s history can teach us about its future

From a company perspective, the current competitive landscape may drive a 'survival of the fittest' dynamic. A focus on long-term, organic, and sustainable EBITDA growth reflects a shift towards fostering operational excellence and resilience. This may result in the emergence of stronger, more adaptable organisations capable of thriving in uncertain economic conditions.

Meanwhile, critics argue that PE’s reliance on leverage and its relatively high valuations may limit flexibility during downturns. Additionally, some LPs remain sceptical about innovations like continuation funds, viewing them as temporary fixes rather than sustainable solutions. That said, the industry’s historical resilience – surviving everything from the global financial crisis to COVID-19 – suggests that it’s well equipped to adapt.

Make informed decisions along your PE journey🔗

Founders and investors alike can benefit from understanding the evolving strategies PE firms use to create value – from operational improvements to navigating liquidity challenges.

For those looking to raise funds, PE firms can offer transformative opportunities. However, their historical approach to long-term growth should be assessed with the appropriate due diligence by founders.