Private Equity Primer:

An Introduction to
Private Equity Basics
PRIVATE EQUITY | MORGAN STANLEY PRIVATE EQUITY SOLUTIONS TEAM | SEPTEMBER 2024

Most investors are familiar with traditional investments, which AUTHOR

include cash and long-only positions in publicly traded stocks MORGAN STANLEY PRIVATE EQUITY
SOLUTIONS TEAM
and bonds. Alternative investments are comprised of more
Founded in 1999, Morgan Stanley
complex investments and include private strategies focused on Private Equity Solutions is a leading
illiquid holdings. Within the private alternatives universe, asset limited partner in private markets
with a 25-year history serving as
classes include private equity, private credit, real estate and a partner of choice to high-quality
infrastructure. Among these asset classes, private equity is one financial sponsors. The team’s broad
private markets investment platform
of the most rapidly growing with assets under management encompasses globally diversified fund of
funds programs, custom mandates, and
quadrupling over the last two decades from $2.2 trillion in specialized programs offering exposure
2000 to $8.5 trillion as of June 2023.1 to primary funds, co-investments,
secondaries, venture capital, and
impact, among other strategies. 2

DISPLAY 1
Differences Between Traditional Investments and Private Investments

TRADITIONAL INVESTMENTS PRIVATE INVESTMENTS

Ownership Publicly traded Privately held

Liquidity High Limited

Investor Base Broad Historically institutional

What Is Private Equity?

Private equity (PE) can be defined as equity or equity-like investments made
into private companies or assets (i.e., not publicly traded or listed on a stock
exchange). In general, private equity fund managers, also known as general
partners (GPs), are analogous to the managers of mutual funds, with a key
difference being that these general partners construct portfolios of privately
held, rather than publicly traded, companies or assets. Like mutual fund
managers, and unlike hedge funds, private equity fund managers acquire long-
only interests in underlying companies (portfolio companies). Unlike their

1
Source: Preqin, February 2024. Alternatives sector includes PE, private credit, real estate,
infrastructure and natural resources.
2
Diversification does not eliminate the risk of loss.
public-oriented counterparts, however, private equity as measured by assets whereby the fund manager making
PE GPs typically hold each of their under management. A buyout typically the venture capital investment (a
portfolio companies for several years. involves a controlling ownership stake venture capitalist) contributes cash to
in a mature company via a secondary the balance sheet of a given company
Following such multi-year hold periods,
investment (i.e., a payment to a in exchange for a minority ownership
a GP will seek to exit its stake in a
shareholder disposing of their equity stake often as part of a syndicate with
company or asset at a gain relative to
position either partially or fully) other investors. The stages of venture
its entry price (or valuation) through a
typically financed with a combination capital financing are often reflective
negotiated sale or initial public offering
of cash and debt. of a company’s maturity and/or size.
(IPO). A GP seeks to deliver gains
For instance, pre-seed and seed
across a portfolio of such companies, „ Growth Equity: Growth equity
investments involve start-up
making PE funds largely illiquid relative investments usually focus on
companies that in some cases have no
to mutual funds. companies that are established but
revenue and only a founding
that are growing much more rapidly
management team; later stage
What Are the Key Private than a typical buyout-oriented
investments target companies that
Equity Strategies? transaction. Additionally, growth
may have billions in revenue and
There are three main strategies within capital investments tend to be
thousands of employees but are not
private equity—buyout, growth equity, financed with lower levels of debt
yet profitable.
and venture capital. All encompass than seen in the buyout segment.
actively constructing and managing Finally, the growth equity segment
tends to be quite flexible with How Can Investors Access
portfolios composed of equity interests
ownership stakes ranging from Private Equity?
in privately held companies that are
minority to majority and Historically, private equity has been
each individually selected in exchange
investments ranging from full associated primarily with institutional
for either a capital investment into a
primary to full secondary. investors and family offices that meet
company (primary) or as a payment to
certain requirements for wealth,
an existing equity holder (secondary). „ Venture Capital: Venture capital
income, or financial knowledge (i.e.,
The strategies’ target investments investments are generally made in
qualified purchasers) and that can
vary, however, in terms of ownership early-stage businesses that have the
tolerate illiquidity and a relatively
levels, portfolio company stage, and/or potential to grow very quickly, but
long investment horizon.3 However,
financing approach. that rely on one or multiple rounds of
several recent innovations are making
Buyout: Buyout investments represent investment funding in order to achieve
„
PE investing more widely accessible to
the largest strategy segment within such growth. As such, venture capital
individual investors.
investments are primary in nature

DISPLAY 2
Ways Investors Can Access Private Equity

PRIVATE COMPANY PRIVATE EQUITY FUND MULTI-MANAGER FUND

„ Direct investment in a pre-identified „ An investment vehicle that pools capital from „ Similar investment vehicle structure to a
privately held asset whereby an investor investors, or limited partners (LPs), which the private equity fund. However, instead of
might acquire a direct equity interest in GP then uses to invest in a portfolio of pooling commitments to invest in
that company underlying private companies or assets underlying companies, the fund invests in
„ Promising upside potential if one „ Moderate upside potential if one selects well other private equity funds
selects well „ Diversification via exposure to multiple „ Unique way for investors to gain access to
„ High concentration risk companies 4 strategies or managers that may otherwise
be difficult for investors to access alone
„ Can be difficult to access attractive „ Concentration risk, as the success of the fund
opportunities depends on a single manager’s ability to „ Broad diversification by providing exposure
execute strategic and operational initiatives to a variety of asset classes, sectors,
to drive value and to sell underlying investment approaches, and managers from
companies in order to realize gains a single investment4

3
Qualified purchasers can be individuals or institutions based on one of several criteria, such as ownership of at least $5 million worth of investments.
4
Diversification does not eliminate the risk of loss.

2 PRIVATE EQUIT Y PRIMER: AN INTRODUC TION TO PRIVATE EQUIT Y BASICS | SEPTEMBER 2024
Today, a number of options exist for
DISPLAY 3
investors to access the illiquid private U.S. Private Equity Cambridge Associates (CA) Horizon Pooled Returns
equity sector. Versus Public Market Equivalent (Russell 2000)6,7

A Closer Look at Opportunistic 17.9%

16.3%
Multi-Manager Strategies 15.6%
14.6%
Opportunistic multi-manager strategies
12.4%
offer diversification as well as other
potential benefits such as return 9.8%
8.5%
enhancement, fee mitigation, and better 7.2%
capital velocity.5 Two such strategies
include co-investments and secondaries.

CO-INVESTMENTS 5 Year 10 Year 15 Year 20 Year

A private equity co-investment is
■ US Private Equity CA Horizon Pooled Net IRR ■ mPME Russell 2000 Index
an investment made into a private
company or asset alongside a GP Source: Cambridge Associates (CA) Horizon Pooled Returns and Russell 2000
who typically serves as the control
and active owner of the asset. A
What Are the Phases of Private will draw capital committed by
co-investment opportunity may arise
Equity Funds? investors to fund those investments.
when a GP seeks to acquire a company
Private equity funds typically have This is followed by the value
for which the required investment „
three phases—portfolio construction, creation phase when the GP focuses
capital is greater than what the GP’s
value creation, and harvest. on implementing various strategic
fund can commit. Funds of funds can
often invest in co-investments at a fee „ During the portfolio construction and operational initiatives to increase
level lower than what is charged by phase, the GP identifies attractive the value of portfolio companies.
a primary fund and sometimes offer investments that fall within scope of During this time, the value of the
exposure to hard-to-access private its predetermined investment unrealized portfolio companies may
companies. Since a co-investment is strategy. During this period, the GP grow, and it is possible that LPs may
made in a specific company rather than
a fund, investors have greater visibility
into the investment and often benefit DISPLAY 4
from shorter duration. Number Of U.S. Companies Versus U.S. Publicly Listed Companies
As of September 2023
SECONDARY TRANSACTIONS
Private equity secondary transactions
are investments in which an investor
NUMBER OF U.S. COMPANIES *
is buying an existing interest or asset The number of companies operating in
from another investor. Secondary the U.S. is approximately ~735,000
transactions allow flexibility for LPs
who wish to liquidate or rebalance
NUMBER OF U.S. PUBLICLY LISTED COMPANIES **
a portfolio. Buyers of secondaries, The number of companies publicly listed in
meanwhile, may benefit from shorter the U.S. is approximately ~4,400
duration, faster return of capital,
potentially discounted access, and *
Source: NAICS Association, as of March 2023. Includes firms with over 20 employees
enhanced transparency into the **
Source: World Federation of Exchange – Number of listed domestic companies in Nasdaq and NYSE,
underlying portfolio or assets. as of September 2023

5
Diversification does not eliminate the risk of loss.
6
CA Modified Public Market Equivalent (mPME) replicates private investment performance under public market conditions. The Russell 2000 Index is a
small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell Index
7
Past performance is not indicative of future results.

SEPTEMBER 2024 | PRIVATE EQUIT Y PRIMER: AN INTRODUC TION TO PRIVATE EQUIT Y BASICS 3
 begin to receive distributions as a „ Lower Correlation to Public Markets. „ Perceived Cost. Private equity can be
result of sales of underlying PE can help diversify an investor’s an attractive asset class, but there is a
companies that have achieved the portfolio by mitigating public market cost associated with accessing the
GP’s intended value creation plan risk.8 PE funds offer lower correlation illiquid private market. Exposure
and that have attracted a new buyer. to public market movements because obtained via commitments to private
GPs seek to create value by growing equity funds includes management
„ Finally, during the harvest phase, the
revenue, improving earnings, fees and carried interest. GPs
GP is focused on positioning the
consolidating platforms, and/or generally charge a management fee,
companies for exits via private sales
repositioning strategies. which covers the normal operational
or IPOs. The capital or profits are
costs of a GP. In addition, GPs receive
distributed back to investors once „ Higher Potential Return. Historically,
a share of LP profits, also known as a
the portfolio companies are realized PE has offered compelling, long-term
performance fee or carried interest.
(i.e. sold) typically on a company-by- returns to investors relative to public
The performance fee is generally
company basis. equity returns. Display 3 demonstrates
subject to an appropriate preferred
that over long periods of time, private
return (i.e., a hurdle rate).10,11
What Are the Key Factors for equity investing has historically
Investors to Consider? provided a material premium over the „ Greater Alignment of Interest. There
Private equity investing offers relevant public benchmark.9 is strong alignment of interest in
distinctive qualitative characteristics private equity where the interests of
„ Deeper Opportunity Set. Of the
that differentiate the asset class. These the GPs and the investors are closely
over 735,000 companies operating
factors include: matched, which ensures that both are
in the United States, 99% of those
working toward the goal of achieving
„ Illiquidity. Private equity is generally companies are privately held as
compelling performance. Alignment is
less liquid than public equity. Private shown in Display 4. Given the
achieved through meaningful GP
equity funds typically have a breadth of private companies, the
personal commitments to the funds
contractual initial life of 10 years in the private equity asset class offers
and through performance fees, where
form of a limited partnership, and the investors exposure to opportunities
GPs receive a share of profits. The
funds do not offer fund redemptions they could not otherwise access via
GP’s personal financial stake and
or investor liquidity. However, the public markets alone. The asset class
performance fee structure incentivizes
market rewards investors with greater can offer exposure to much smaller
GPs to maximize investor returns, as
profit potential to compensate for this companies than those represented in
their compensation is directly tied to
relative lack of liquidity. public markets.
the success of the fund.

8
Diversification does not eliminate the risk of loss. volatility and risk of loss. Alternative investments typically have higher fees
and expenses than other investment vehicles, and such fees and expenses
9
Past performance is not indicative of future results.
will lower returns achieved by investors.
10
The level of return that must be achieved by the GP before they are able
This material is a general communication, which is not impartial, and all
to claim carried interest. information provided has been prepared solely for informational and educational
11
For discussion purposes only. All terms are subject to a final definitive agreement. purposes and does not constitute an offer or a recommendation to buy or
sell any particular security or to adopt any specific investment strategy. The
IMPORTANT
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buy or sell any particular security or to adopt any specific investment strategy.
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