Private equity is a way for big investors to pool money, buy companies, make them more profitable and sell them for a profit, usually within 5 to 10 years. Legoland, Hilton Hotels and Ancestry.com have something in common: they were all owned by Blackstone, the biggest private equity firm in the world, according to the script behind the video. In 2024 the market was valued at $460 billion, and it is projected to reach $1.3 trillion within ten years, which the video compares to the GDP of Turkey, the Netherlands and Saudi Arabia.
Any company needs money to grow fast, and it can get it two ways: sell shares to the public, or sell pieces of the company to private investors. The second is private equity. This article covers the four steps, where it came from, the four strategies and why the firms get so rich.
Watch the full video here, or skip to the breakdown below.
How private equity works at a glance
- The four steps
- Where it came from
- Leveraged buyouts
- Growth equity and venture capital
- Distressed investing
- How the firms make so much money
The four steps
Firms follow a simple sequence.
- Raise money from outside investors and put it into a special fund.
- Use the fund to buy companies.
- Make the companies profitable. The firm restructures to lift profits, which can mean new leadership, layoffs, new locations or better marketing and branding. Sometimes it leads to huge success and sometimes it backfires.
- Sell for a profit. After 5 to 10 years the firm exits through an IPO, a sale to another company or a sale to another private equity firm.
If everything goes as planned, the firm sells for much more than it paid, and the firm and its investors make a massive profit. They never intend to hold on and pocket the earnings. They buy intending to sell as soon as it makes sense.
Where it came from
In the early 1900s, tycoons like J.P. Morgan, the Rockefellers and the Vanderbilts were already buying companies with investor money. They did not flip them. They bought several firms in the same industry, merged them into massive corporations and built from there, a bit like collecting same-colored properties in Monopoly before building hotels.
After World War II the economy boomed and millions of veterans came home. In 1946 Georges Doriot, a Harvard professor, created the American Research and Development Corporation, the first real venture capital firm. Its biggest bet was Digital Equipment Corporation. It put in just $70,000, and when the company went public in 1968 the stake was worth $355 million.
By the 1980s private equity turned to buying existing companies and making them profitable, with both spectacular successes and bankruptcies. In the 1990s and early 2000s pension funds, university endowments and governments started pouring money in. After the 2008 crisis regulation tightened, and firms focused on improving operations, bringing in better management and using technology. Today Blackstone, Carlyle and Apollo manage trillions of dollars across real estate, credit and infrastructure.
Leveraged buyouts
J.P. Morgan’s 1901 acquisition of Carnegie Steel is considered the first major leveraged buyout, or LBO, the best-known type of private equity. An LBO uses pooled investor money, and modern ones also borrow heavily, backed by the target company’s own assets and future earnings. A lender sees high risk, which allows high interest rates, plus debt secured against real assets and large potential returns.
Hilton is the success story. Blackstone bought it for $26 billion in 2007, appointed a new CEO, moved the company away from owning real estate toward brand management and franchising, and injected $800 million. That allowed bigger loans, which funded renovation, marketing and expansion. Hilton went public again in December 2013 at $21.50 a share, and by 2018 Blackstone had fully exited, making about $14 billion in profit over 11 years.
Toys R Us is the botched one. In 2005 several firms bought it for about $6.6 billion with the debt placed on its balance sheet. There was no cash injection. Between 2005 and 2017 the firms collected more than $470 million in fees and interest from the company. With that debt load, it could not improve stores or upgrade to e-commerce, fell behind, and filed for bankruptcy after 12 years. More than 800 stores closed and thousands lost their jobs.
Cases like Toys R Us are why private equity attracts criticism and controversy.
Growth equity and venture capital
Growth equity is the more reliable cousin of venture capital. Firms invest in established, fast-growing and already profitable businesses that need capital to scale, enter markets or develop products. Deals use little or no debt, and the firm usually buys a minority stake instead of control. Doriot’s DEC bet was really this strategy. General Atlantic and KKR invested in ByteDance, TikTok’s parent company, which helped it scale quickly.
Venture capital is the high-risk, high-reward side: money into small, unproven startups hoping for billion-dollar companies. Sequoia invested early in Airbnb, Google and WhatsApp, and Andreessen Horowitz in Skype, Facebook and Twitter. Not every deal works. Sequoia put $214 million into the crypto exchange FTX and lost all of it when it collapsed in 2023, and venture capitalists put $700 million into Theranos and lost it when the technology was found to be fake.
Distressed investing
The strategy that causes the most controversy is distressed investing: buying struggling or bankrupt companies at a discount and trying to turn them around. Sometimes it works. OpCapita bought Game UK, restructured heavily, and within two years raised its market value to more than twelve times what it paid.
Other times firms cut costs so aggressively and sell so many assets that the company ends up worse off. In 1969 Victor Posner of DWG Corporation executed a hostile takeover of Sharon Steel at a discount and began restructuring it. Sharon Steel filed for bankruptcy in 1987. In 2024 alone, 110 companies backed by private equity filed for bankruptcy, yet private equity has still turned investors into billionaires.
How the firms make so much money
The answer is in how deals are structured. From a single deal a firm creates several income streams, it is not liable for repaying the loan, and it contributes only about 10% of its own money to the fund.
- Fees: management fees are usually 2% of the assets under management, plus performance fees of 20% of profits. Even if a deal struggles, the firm still collects millions or billions for managing the fund.
- Exit timing: firms look for the sale that makes the most money, whether an IPO, a competitor or another firm, and time it for peak valuation. Restructure a business and sell it for $20 billion, and you can return ten times the original investment.
- Debt: the acquired company pays the loan, and the interest is tax-deductible, so the business keeps more of its earnings. Since the firm put in only a fraction of the price, the return can be 5x or 10x rather than 2x.
That is how firms like Blackstone, KKR and Apollo end up managing trillions and owning hotels, media companies and tech companies. In the video’s words, they own half the world.
The takeaway
Private equity is a repeatable machine: pool money, borrow against the target, restructure, and sell at the right moment while collecting fees along the way. It can create stories like Hilton and wrecks like Toys R Us, and the structure explains why the firms profit in both cases.
The video says it has only scratched the surface, and points to an expert collection on buying businesses coming to the Alux app from entrepreneur Aram Taghavi.
FAQ
What is private equity in simple terms?
A way for big investors to buy companies, make them better and sell them for a profit. Firms raise a fund from outside investors, buy companies with it, improve profitability and exit after 5 to 10 years.
What is a leveraged buyout?
A deal where a firm buys a company with pooled investor money plus borrowed funds, backed by the target company’s own assets and future earnings. The first major one was J.P. Morgan’s 1901 purchase of Carnegie Steel.
How do private equity firms make money?
They charge management fees of about 2% of assets and performance fees of 20% of profits, time exits for peak valuations, and use debt that the acquired company repays, so their own contribution is only about 10%.
What is the difference between private equity and venture capital?
Venture capital backs small, unproven startups in a high-risk, high-reward bet. Leveraged buyouts take existing companies and restructure them, while growth equity backs established, profitable firms with little or no debt.
Why did Toys R Us fail after its buyout?
The debt sat on its own balance sheet, there was no cash injection, and the firms collected more than $470 million in fees and interest. It could not invest in stores or e-commerce and filed for bankruptcy after 12 years.
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