Private equity as an asset class delivers strong returns to investors, often better than public market benchmarks (see Chart of the Week). It also diversifies investor portfolios with access to smaller high-growth private companies. As PE becomes available to high-net-worth investors, understanding how these investments work is essential for a sophisticated wealth program. 

While the first buyers of middle market companies were not strictly PE firms, so-called leveraged buyouts (LBOs) quickly became their focus. Think of PE sponsors as investment businesses that buy private companies (or take public companies private) using a combination of debt and equity, boost their value, and sell them for a profit—typically within 3 to 7 years.

The first thing to understand about buyouts is why they happen at all. Families or entrepreneurs can be challenged to grow their companies without outside capital, especially those too small to go public or issue bonds. Banks provide working capital, but not equity. It’s also difficult for founders to realize value in cash without selling their businesses to a competitor. A PE firm can buy some or a majority of that ownership, allowing the seller upside.