Table of Contents
The Fundamentals of Private Equity: How Deals Are Structured
- CLFI Team
- 7 min read
Private equity has become one of the most influential forces in global finance, shaping industries, ownership structures, and strategic decision-making in mature companies. Its long-term orientation, active governance, and ability to deploy substantial capital distinguish it from public market investment strategies that prioritise liquidity and short-term price movements. The asset class operates on the principle of acquiring significant ownership in private companies, improving their performance, and exiting at a valuation that reflects the value created. This approach demands discipline, specialist expertise, and a comprehensive understanding of how value is generated through both financial structuring and operational change.
What Private Equity Is
Private equity is an asset class focused on investing in companies that are not listed on public exchanges. The investments are made through long-dated capital commitments, usually ten years or more, that allow private equity funds to take significant ownership stakes in their portfolio companies. These stakes provide the authority to influence or directly shape strategy, operations, and governance. The investment model aims to generate returns through value creation rather than passive exposure to market movements. This approach makes private equity fundamentally different from traditional public market investing, where liquidity and short-term price dynamics play a larger role.
Definition:
Private Equity
An investment model focused on acquiring significant stakes in non-public companies, improving their financial and operational performance, and exiting at higher valuations through sales, recapitalisations, or public offerings.
Although private equity typically focuses on private firms, there are circumstances where funds invest in public companies. These include mechanisms such as Private Investments in Public Equity, commonly known as PIPE transactions. However, the core of the asset class centres on companies in their expansion to maturity stages. The emphasis on established businesses differentiates private equity from venture capital, which invests in early-stage companies with limited operating history. Understanding these structural distinctions clarifies why private equity firms emphasise governance, operational enhancement, and capital efficiency as part of their investment approach.
Private Equity and Public Markets
Private equity contrasts sharply with public markets in three ways. First, public equity offers daily liquidity, allowing investors to buy and sell shares at any time. Private equity requires capital to remain committed for extended periods so that the investment thesis has time to materialise. Second, public markets operate within a framework of dispersed ownership. Shareholders usually have limited influence over management decisions and corporate strategy. In private equity deals, ownership is concentrated. Investors acquire sufficient control to influence major decisions, giving them the capacity to change leadership, adjust cost structures, or reconfigure the business model. Third, public markets are driven by short-term reporting cycles, whereas private equity benefits from a multiyear planning horizon that supports transformative initiatives.
The long time horizon and active involvement provide private equity firms with a comprehensive platform to analyse every aspect of a company’s operations. This approach enables them to implement initiatives that require sustained effort, such as improving supply chains, refining product lines, enhancing pricing structures, or expanding internationally. Public markets rarely offer the same level of access or influence. This difference helps explain why private equity has been a significant contributor to restructuring mature sectors and repositioning companies facing competitive pressure.
Programme Content Overview
The Executive Certificate in Corporate Finance, Valuation & Governance delivers a full business-school-standard curriculum through flexible, self-paced modules. It covers five integrated courses — Corporate Finance, Business Valuation, Corporate Governance, Private Equity, and Mergers & Acquisitions — each contributing a defined share of the overall learning experience, combining academic depth with practical application.
Chart: Percentage weighting of each core course within the CLFI Executive Certificate curriculum.
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Deal Structuring in Private Equity
Once a private equity firm identifies a target company and completes its due diligence, it must determine how to structure the investment. Deal structuring involves deciding the optimal mix of equity and debt, assessing repayment capacity, and identifying the contractual terms that govern the relationship between the private equity firm and the company. This stage is critical because it defines the distribution of risk and return across all parties involved in the transaction. In addition to financing considerations, deal structuring covers legal arrangements, governance rights, board composition, and the authority to install key executives. It is, in effect, the foundation on which the investment’s success will be built.
Definition:
Deal Structuring
The set of financial, legal, and governance arrangements that define how a private equity investment is financed, controlled, and managed from acquisition through exit.
Deal structuring requires a careful understanding of the company’s capital needs, operational challenges, and growth opportunities. A well-structured deal aligns incentives, ensures sufficient cash flow to service debt, and protects the private equity firm’s downside while preserving the company’s operational flexibility. Different approaches offer different combinations of protection, influence, and upside potential, and the chosen structure reflects both market conditions and the specific risks associated with the target company.
Three Core Approaches to PE Deal Structuring
Private equity firms commonly use three approaches when structuring an investment. The first is plain vanilla equity, which involves purchasing shares directly from the existing owners at an agreed valuation. This approach provides immediate ownership and creates a direct alignment between the private equity firm and the company’s future performance. It is often used when the private equity firm wants an unambiguous equity position and clear governance rights.
The second approach involves the use of convertible bonds. Convertible bonds offer downside protection by guaranteeing a fixed return if the company does not meet its performance targets. At the same time, they provide the option to convert the bonds into equity if the company’s performance improves. This combination of income and potential upside makes convertible bonds particularly useful in situations where the company has strong prospects but faces near-term uncertainties. They align incentives by encouraging performance while balancing risk through predictable interest payments.
The third method is the leveraged buyout, a structure that uses a significant amount of borrowed capital to finance the acquisition. The debt is repaid through the company’s future cash flows. Leveraged buyouts increase the private equity firm’s potential return because only a portion of the purchase price is financed with the firm’s own equity. However, they also require rigorous cash-flow management to ensure that the company can service the debt without compromising its operations. This strategy works best for companies with stable, predictable earnings and strong market positions.
Applied Example: Bayes Equity and CLFI Executive
Consider a hypothetical private equity firm, Bayes Equity, assessing a potential investment in CLFI Executive, a mature professional education company preparing to enter several new European markets. Following detailed due diligence, Bayes Equity concludes that CLFI Executive has an established product set, a stable customer base, and opportunities for controlled expansion. Bayes must now evaluate which investment structure provides clarity, appropriate risk management, and alignment with the company’s operating profile.
A standard equity investment would provide Bayes with an immediate ownership position and a clear governance role. This structure is straightforward, avoids financial strain on the company, and ensures that expansion efforts are supported without introducing fixed repayment obligations. Alternatively, if short-term performance carries uncertainty, Bayes might consider a convertible bond. This instrument provides funding while postponing the final determination of ownership until the business demonstrates its trajectory. The fixed interest element, however, introduces a recurring payment requirement that management would need to plan for carefully, particularly during a growth phase where cash should ideally be allocated to operations and market development.
A debt-heavy acquisition structure, such as a leveraged buyout, is generally less suitable for organisations where investment in product, technology, and market expansion remains essential. While such structures appear to offer the possibility of acquiring a larger stake, they place the operating company under financial obligations that can restrict capacity to recruit, upgrade systems, or pursue strategic initiatives. For a company like CLFI Executive, whose long-term competitiveness depends on continued reinvestment, the introduction of significant debt would likely reduce strategic flexibility rather than enhance it. The comparison of these structures illustrates how the choice of investment approach must reflect not only ownership considerations but also the long-term sustainability of the business.
Definition:
Risks of Debt and Private Credit
Debt introduces fixed obligations that reduce financial flexibility, increase insolvency risk, and amplify losses when performance deteriorates. These risks are particularly visible in the fast-growing private credit market, an opaque segment of the shadow banking sector, where loans are issued by non-bank institutions that face minimal regulatory scrutiny.
Recent failures highlight how excessive borrowing can trigger wider financial instability. The collapses of US firms First Brands and Tricolor resulted in substantial losses for regulated banks exposed to their private credit financing, including Jefferies (reporting a $715m exposure) and JP Morgan (recording a $170m loss). These cases demonstrate how debt-supported business models can quickly unravel, with losses spreading beyond the original borrower.
The broader private credit industry is dominated by major alternative asset managers such as Blackstone, Apollo, Ares, and KKR. Their lending activities often sit outside traditional regulatory frameworks, limiting transparency and preventing regulators from assessing the true value and risk profile of underlying loans. This opacity increases the likelihood that problems remain hidden until defaults occur, at which point both borrowers and lenders may face sudden and severe financial stress.
In practice, high leverage restricts a company’s capacity to invest, weakens operational resilience, and heightens the probability that even moderate earnings volatility leads to covenant breaches or failure. When combined with the opaque nature of private credit markets, the use of debt can generate systemic vulnerabilities that affect banks, investors, and pension funds linked to these structures.
In Practice
In practice, private equity’s effectiveness rests on the combination of rigorous deal structuring, active governance, and a disciplined approach to operational improvement. Private equity investors take the time to understand the businesses they acquire, analyse how those businesses generate value, and determine which interventions will have the greatest impact. The long-term orientation of the asset class enables initiatives that would be challenging to implement in a public market context, where short-term reporting cycles can discourage transformative projects. Private equity firms have the advantage of being able to install new leadership, redesign incentive structures, or undertake strategic repositioning with clarity and control.
The role of governance is especially significant. Private equity firms often install robust board structures, implement detailed reporting systems, and align management incentives with clear performance targets. These arrangements help ensure that operational improvements translate into measurable financial results. This discipline has made private equity an influential owner across multiple sectors, ranging from technology and healthcare to industrials and consumer products. The asset class is not without risks, and success requires careful management of leverage, strategy, and execution. However, when these elements are aligned, private equity can deliver strong long-term returns to investors while building more resilient and competitive companies.
For executives, entrepreneurs, and board members, understanding the fundamentals of private equity is essential. It clarifies how investment partners think, what they prioritise, and how their involvement will shape strategic decision-making. It also provides a foundation for evaluating whether private equity capital aligns with the organisation’s objectives. As the asset class continues to grow in scale and sophistication, this knowledge has become indispensable for leaders navigating capital markets and competitive environments.