Private equity is a form of investing where firms buy companies that aren't publicly traded on a stock exchange, improve them, and sell them for a profit — typically over 7 to 12 years.
You've probably heard the term "private equity" tossed around in business news, podcasts, or maybe at a dinner party where someone was trying a little too hard to sound impressive. It's one of those finance terms that gets used a lot but rarely gets explained clearly.
And that's a shame, because private equity (PE) plays an outsized role in the global economy. PE firms own everything from grocery chains to software companies to the clinic where you get your teeth cleaned. In Canada, some of the country's biggest institutional investors — like pension funds — have been pouring money into PE for decades.
For most of its history, PE has been reserved for institutional investors and the ultra-wealthy. But understanding how it works is useful for anyone who wants to make sense of modern finance.
This article covers what PE actually is, how firms operate, where the returns come from, and whether everyday Canadians can get a piece of the action.
What is private equity?
At its simplest, PE is ownership of companies that aren't listed on a public stock exchange. When you buy shares of a company on the Toronto Stock Exchange (TSX) or New York Stock Exchange (NYSE), that's public equity. When an investment firm buys a company — or a stake in one — through a private transaction, that's PE.
PE firms raise large pools of capital from investors, use that money to acquire companies, and then work to increase those companies' value before selling them. The goal is to buy a company, make it more valuable, and sell it at a profit.
Canada's major pension funds allocate a larger share of their portfolios to PE than most of their global peers. The Canada Pension Plan (CPP) Investment Board, known as CPPIB, and the Ontario Teachers' Pension Plan (OTPP) both dedicate significant portions of their portfolios to PE — which means if you're a Canadian worker with a pension, you likely already have some indirect exposure to PE through them.
How do private equity firms work?
PE firms don't just buy companies and sit back. They're active owners with a specific playbook: acquire a company, make it more valuable, and exit at a profit.
The buy, improve, sell cycle
The process typically follows three stages:
Acquisition: the PE firm identifies an undervalued or underperforming company. It raises capital from investors, often combines it with borrowed money (more on that later), and buys the business — sometimes taking a public company private, sometimes acquiring a family-owned business or a division of a larger corporation.
Improvement: this is where the real work happens. PE firms create value in two broad ways.
Operational improvements: the hands-on work of making the underlying business better. This means bringing in new management, cutting costs, investing in technology, expanding into new markets, or restructuring operations. The goal is to grow revenue, improve margins, or both. Think of it like renovating a house: new kitchen, better layout, more square footage — you're increasing what the property is fundamentally worth.
Financial engineering: changing the company's capital structure to amplify returns, without necessarily changing the business itself. The classic tool is leverage: PE deals are often funded largely with debt (hence "leveraged buyout"), so a relatively small slice of equity controls the whole company. Debt isn't simply something to pay down — maintaining a certain level of it is often optimal, since it's an important source of financing alongside equity and helps support the company's capital structure. Returns come from how that structure is managed: equity value can grow as debt is paid down with the company's cash flow, but also through refinancing on better terms, optimising the tax structure, or paying out dividends funded by new debt (a "dividend recapitalisation").
The two levers aren't equally reliable, though. Operational improvements tend to produce more consistent, durable outcomes, because a genuinely better business is worth more regardless of market conditions. Financial engineering is more dependent on the environment — it works best when debt is cheap and plentiful. When the cost of borrowing is high, leverage becomes a drag rather than a boost, and strategies that lean on it can struggle or fail outright. That's a large part of why the industry increasingly emphasises operational value creation: it's the source of return a manager can actually control.
Exit: after several years of improvements, the private equity manager sells the company. Common exit routes include an initial public offering (IPO), a sale to another PE firm, or a sale to a strategic buyer like a larger corporation. There are also a range of other ways to generate liquidity for investors — such as recapitalisations, NAV financing, and GP-led transactions — without fully exiting the business.
The entire cycle usually takes 7 to 12 years per deal, though some investments are held longer.
How private equity funds are structured
PE firms don't invest their own money alone. They raise funds from outside investors, and the structure of those funds is central to how the industry works.
General partners and limited partners
A PE fund has two types of participants:
General partners (GPs): the PE firm itself. GPs manage the fund, source deals, oversee portfolio companies, and make investment decisions. They typically invest 1% to 5% of the fund's total capital alongside their investors — enough to have skin in the game.
Limited partners (LPs): the investors who provide the bulk of the capital. LPs include pension funds, endowments, sovereign wealth funds, insurance companies, and high-net-worth individuals. They commit a certain amount of money upfront, but they don't hand it all over on day one.
Instead, the GP calls capital over time as it identifies and closes deals. This process is known as a capital call. LPs must be ready to wire their committed capital when the GP asks for it — sometimes with as little as 10 days' notice.
Fees and carried interest
PE funds typically charge two layers of fees:
Management fee: usually 1.5% to 2% of committed capital per year, paid to the GP to cover salaries, deal sourcing, and operations.
Carried interest (carry): the GP's share of profits, typically 15% to 20% of gains above a minimum return threshold (called the hurdle rate, often around 5% to 8%). This is the GP's main incentive to generate strong returns.
This is the famous "2 and 20" model. It means LPs pay 2% annually whether the fund makes money or not, and the GP takes 20% of profits if the fund performs well. Critics argue the structure is expensive. Defenders argue it aligns the GP's interests with the investors'.
The J-curve and typical time horizons
If you invest in a PE fund, don't expect to see positive returns right away. In fact, expect the opposite.
The J-curve is a pattern that describes how PE fund returns look over time. In the early years (typically years 1 through 4), returns are negative. That's because the fund is paying management fees, drawing down capital, and acquiring companies that haven't had time to appreciate in value yet.
As the portfolio companies mature and the GP executes its improvement plans, returns start to climb. By the middle years, the fund's value usually crosses back to break-even. In the later years (years 5 through 12), the GP exits investments, and returns can rise sharply.
The J-curve is one reason PE isn't for the impatient. Fund lifetimes typically run 10 to 12 years, and investors usually can't withdraw their capital during that period. You're locked in — for better or worse.
Why private equity has historically outperformed public markets
But it's important to understand what that headline figure hides: while median private equity returns have outperformed public markets, that also means a substantial share of managers have underperformed. This is why manager selection is so critical. Capturing attractive returns depends on identifying and partnering with managers who consistently beat the median — and ideally rank among the top quartile of performers. And even for strong managers, those returns don't come from nowhere.
How debt amplifies returns
Most PE deals involve significant amounts of borrowed money. When a firm buys a company for $500 million, it might put up $200 million in equity and borrow the remaining $300 million. If the company's value rises to $800 million, the equity investors don't just earn a 60% return — they earn a 150% return on their $200 million, because the debt stays fixed.
Of course, this works in reverse too. If the company's value drops, the equity investors absorb the losses first. High levels of debt magnify both gains and losses.
It's worth noting that leverage is a less dependable driver of returns than it might appear, because it's highly sensitive to market conditions. It often depends on access to low-cost financing, so its success is contingent on a favourable interest rate environment. When rates rise, that source of return becomes harder to rely on.
Operational improvements
Compared with leverage, operational improvement is a more reliable source of returns — it's within the manager's control and doesn't depend on market conditions or cheap financing. PE firms don't just rely on financial engineering. They actively work to make their portfolio companies better businesses. Common strategies include:
Management upgrades: hiring stronger leadership teams to improve execution
Cost reduction: cutting unnecessary overhead and improving operating efficiency
Technology investment: deploying new systems and automation to modernise operations
Geographic expansion: entering new markets or product categories to grow revenue
Add-on acquisitions: buying smaller companies to build scale and market share
This hands-on approach is fundamentally different from passive public-market investing, where shareholders have limited influence over how a company is run.
Other factors
Several additional factors contribute to PE outperformance:
Information advantages: PE firms conduct extensive due diligence before acquiring a company, gaining access to detailed financial and operational data that public-market investors don't see.
Longer time horizons: without the pressure to report quarterly earnings, PE-owned companies can invest for the long term — even if short-term results suffer.
Incentive alignment: the carried interest structure means GPs earn the most when their investors earn the most. GPs often give management teams at portfolio companies equity stakes, aligning their incentives too.
Types of private equity
PE is an umbrella term — one of several alternative investment strategies — that covers several distinct approaches:
Leveraged buyouts (LBOs): a dominant form of PE. A firm acquires a mature company using a combination of equity and debt, improves it, and sells it. This is the classic "buy, fix, sell" model.
Growth equity: investing in mature startups that need capital to expand and are typically planning to IPO relatively soon. Less debt is typically involved compared to LBOs.
Venture capital (VC): investing in early-stage startups with high growth potential. VC is technically a subset of PE, though the two industries operate quite differently (more on that below).
Risks of investing in private equity
PE has historically outperformed public markets, but that track record comes with real risks — many of which are common across private assets:
Illiquidity: your money is usually locked up for years, often over the fund's full 10-to-12-year life with no option for early withdrawal. Unlike public stocks, you can't sell a stake on a bad Tuesday afternoon, so you need patience and a long investment horizon.
Manager selection and vintage risk: in public markets, the gap between a good and bad fund manager is usually modest. In private equity, it's enormous — the spread between top-quartile and bottom-quartile funds can run to double-digit annual returns, and unlike public stocks, you can't easily switch out of a poor performer once you're committed for the fund's full life. This makes manager selection one of the most important decisions an investor makes, and access to the best managers is often limited. Vintage risk compounds this: a fund's "vintage" is the year it starts deploying capital, and returns can vary widely depending on what the market looks like during that window. A fund that buys companies at high valuations just before a downturn may struggle, while one deploying into a depressed market can do exceptionally well — largely a function of timing the investor didn't control. Spreading commitments across multiple managers and several vintage years is a common way to manage both risks.
Leverage: the heavy use of borrowed money can amplify losses if a deal goes wrong. Companies with too much debt can — and do — go bankrupt.
Lack of transparency: PE firms aren't subject to the same disclosure requirements as public companies. Investors get periodic reports, but visibility into day-to-day operations is limited.
Higher fees: the 2-and-20 fee structure can eat into returns, especially in funds that don't perform well. A fund that delivers mediocre gross returns can look much worse after fees.
Can you invest in private equity?
In Canada, direct PE fund investment has traditionally been limited to accredited investors — individuals with at least $1M in assets (excluding their primary residence), or an annual income above $200,000. Those thresholds rule out the vast majority of Canadians.
But here's the thing: many Canadians already have exposure to PE without realising it. The CPPIB allocates roughly 30% of its portfolio to PE and private credit. OTPP has a similar allocation. If you're paying into the CPP or belong to a major defined-benefit pension, your retirement savings are partly invested in PE.
Part of what makes broader access possible is a difference in fund structure — specifically, the shift from drawdown to evergreen funds. Traditional private equity uses a drawdown (or closed-end) fund: investors commit a fixed amount upfront, but the capital is "called" in pieces over several years as the manager finds deals, then returned as investments are sold — typically over a fund life of around ten years, after which the fund winds down. It's a finite structure with a clear beginning and end, and investors are locked in for the duration. An evergreen (or open-end) fund works differently: it has no fixed end date and continually accepts new capital and reinvests proceeds rather than returning them on a set schedule. Investors are generally fully invested from day one rather than waiting for capital calls, and many evergreen vehicles offer periodic liquidity windows that allow redemptions, subject to limits. This makes evergreen structures more accessible and simpler to administer — a large part of why they've become the common vehicle for bringing private markets to individual investors — though that flexibility comes with trade-offs, such as holding some cash to meet redemptions, which can be a modest drag on returns, and liquidity that is still limited.
The landscape is evolving. What was once an asset class reserved almost exclusively for large institutions and the ultra-wealthy is opening up — and while it's not quite open to everyone yet, vehicles like evergreen funds are making it accessible to far more investors than before.
