Glossary
Familiarise yourself with the essential terminology of private equity.
A
Acquisition Strategy
Growth through acquiring or merging with other companies to expand market presence or capabilities. The strategy is also known as ‘Buy and Build’ and has become common across the private equity industry, where the financial sponsor seeks to support its investee in creating value through increased scale or market consolidation. For example, by acquiring smaller, often complementary, companies and integrating them under a unified operating model. This process of consolidation is most prevalent in fragmented sectors, where no single company dominates and there are many smaller players.
Alternative Investments
Types of investments that do not fall within traditional categories such as stocks, bonds, and cash. Common alternative investments include private equity, private credit, real estate, and hedge funds. Alternatives tend to have different risk/return characteristics from traditional stock and bond investments and are often used in a portfolio to enhance return potential, provide diversification, and reduce volatility.
Annual Recurring Revenues
Annual Recurring Revenue (ARR) is a long-term revenue stream that a company has generated, or is forecast to generate, typically via a subscription-based model. Key metrics used to measure ARR include new client sign-ups; renewals, which indicate that the product or service continues to deliver value; upsells, where a customer opts to take on additional functionality at a cost to enhance their business; and customer churn, where a client decides they no longer need the product and cancels it. The net effect of these metrics reveals a trend in ARR revenue growth that is critical to investors as part of the valuation process.
Arbitrage
PE or price/earnings arbitrage is the process by which the price at which a business is acquired can be improved through a number of initiatives prior to exit. This can be achieved in various ways, such as through efficiencies, organic growth, acquisitive growth, improving the management team, or adding new products and services that make the business more attractive to a new investor or acquirer. The objective of price/earnings arbitrage is to improve both the quantum of earnings and the multiple of earnings that a new buyer is willing to pay for the business.
Asset Class
A group of investments with similar financial behaviours or characteristics, such as stocks and bonds. Similar asset classes can also be subject to the same laws and regulations. Each asset class has its own level of risk and reward. Investing across different asset classes is a way to diversify a portfolio and spread risk, reducing the potential impact of poor performance in one class within the overall investment portfolio.
B
Blue Chip Companies
Large, established companies with a history of stable earnings and a strong reputation in the market. They are often household names, recognised both nationally and internationally. The term ‘blue chip’ comes from the card game of poker, where blue chips are the highest-value pieces.
Buy and Build
An attractive and potentially lucrative private equity investment strategy that, when used effectively, can significantly increase investor return. It involves acquiring a platform company that can be further built upon over time through bolt-ons to accelerate growth, enhance capabilities, and increase market share. The approach aims to create a larger, more valuable business by consolidating fragmented sectors, achieving economies of scale, and driving operational improvements. Typically, the strategy focuses on sectors with strong fundamentals and opportunities for synergies, with value created through both organic growth and integration of the acquired businesses. This method allows investors to generate returns not just from individual company performance, but from the value uplift of the combined group.
C
Capital Call
A request made by the General Partner for Limited Partners to contribute their committed capital as needed. GPs typically require time to source and secure all the target assets in private equity therefore the timing of investments is often uncertain. Rather than collecting the full investor commitment at the outset and funds potentially sitting idle for a period GPs employ capital calls, allowing investors to retain their capital until specific assets have been identified and are ready for investment. The capital call model offers significant advantages for LPs, primarily by giving them greater control over their cash flows, appealing to those seeking lower upfront commitments or requiring greater liquidity management. For GPs, the model enhances fund efficiency by reducing the cash drag associated with idle capital and allowing more flexibility around capital deployment to align with market opportunities as and when they arise.
Capital Expenditure
Often referred to as CapEx, capital expenditure is investment made by companies to acquire, maintain or upgrade physical or fixed assets such as machinery, buildings, infrastructure and hardware. When a company make a capital expenditure it will increase the value of its fixed or capital assets on the balance sheet. Private equity firms need to carefully analyse and manage CapEx within its portfolio companies as it has a direct impact on cash flow and profitability therefore impacting the value of the underlying investment.
Capital Gain
The profit realised from the sale of an investment for more than its original purchase price. Most capital gains are subject to Capital Gains Tax (CGT), with a common example being the sale of shares. However, there are certain circumstances in which CGT does not apply, such as when investments are held within an ISA or when disposing of Venture Capital Trust (VCT) shares, which are exempt.
Carried Interest
Carried interest is an incentive scheme for the General Partner to share in the profits from successful investments. It pays out once the manager has made a number of significant realisations, generated positive returns and have exceeded a hurdle (the minimum return that an investor must achieve before the GP is entitled to carried interest). The GP will typically share in any excess proceeds above that investment return hurdle, normally 20% of the excess.
Corporate Governance
The system of rules, practices, and processes by which a company is directed and controlled. It is the framework which lays the groundwork to an organisations approach to all business activities creating accountability, driving efficiencies and responsible decision making. Example of corporate governance can include the board of directors, risk & crisis management, workplace ethics, ESG principles and regulatory compliance. Maintaining control over governance is an important constituent of a well run business and is a key component that helps drive value and returns in private equity.
D
Deferred Consideration
Also referred to as an ‘earn-out’, deferred consideration is an effective tool used during the M&A process to help bridge the gap between the seller's and buyer's price expectations, where a portion of the purchase price is paid at a later date or is contingent upon certain conditions being met, such as revenue targets or profitability thresholds. Its implementation offers benefits to both sides. For buyers, it reduces the initial upfront investment and can mitigate the risks of future performance, while for sellers, it could help them achieve a potentially higher overall return on their sale if performance targets are met.
Diversification
Spreading investments across various assets to reduce risk exposure to any single asset or risk factor. Diversification is one of the central pillars of sensible investing which balances risk vs reward and helps support steadier performance over time. It provides a hedge against market volatility, smoothing out the effects of underperforming investments, reducing concentration in one asset and providing an opportunity for additional sources of return.
Dividend Yield
The percentage of a company's annual dividend per share relative to its current net asset value or share price. The NAV of a fund will typically decline following any distribution, but this is not a financial loss and the reduction will mirror the level of dividend paid. Dividend yield can offer valuable insights into a company’s or fund's financial health and income potential. A stable or growing yield may indicate stability and confidence, while providing investors with a regular income stream. However, high yields may also mask underlying issues, and paying dividends can restrict a company’s ability to reinvest for growth.
Dry Powder
A term used to describe committed capital held by a private equity firm but is yet uninvested. These reserves are cash that has already been raised and is available for future investments. Dry powder is essential for private equity funds allowing them to competitively bid on potential investment opportunities and providing a certainty of funds to the seller. Dry powder also allows private equity fund portfolio companies to weather volatility in the market or to deploy capital opportunistically. The meaning dates back to the 17th century when soldiers had to carefully store dry gunpowder in order for their weapons to fire.
Due Diligence
An essential part of the investment process, involving a detailed and critical review of every aspect of a potential investee company. Due diligence is done pre-investment and is normally undertaken by specialist providers that offers expert assistance across aspects such as financial, legal, insurance and commercial. It serves as crucial step in understanding and mitigating risk, but can also identify enhancements to the target business. The key purpose of due diligence is to enhance an investors understanding of crucial information underpinning a potential investment to enable it to make informed investment decisions.
E
EBITDA
Abbreviated from Earnings Before Interest, Taxes, Depreciation, and Amortisation, EBITDA is a key financial metric used to assess a company's profitability. It is a cornerstone calculation used across the investment industry and is useful for normalising a company's financial results, as it does not take account of individual capital structures, meaning it is easier to evaluate a business and compare it against others.
Enterprise Investment Scheme (EIS)
The Enterprise Investment Scheme (EIS) is a UK government initiative launched in 1994 to encourage investment in early stage businesses with high growth potential. Its primary goal is to stimulate economic growth by providing investors with attractive tax incentives to support these innovative, but often high-risk companies, that may otherwise struggle to secure funding. Tax reliefs available through EIS include income tax relief of up to 30%, capital gains tax relief and 100% inheritance tax exemption. EIS-qualifying companies are usually small and privately owned, typically with gross assets under £15 million at the time of investment fewer than 250 employees. There are two ways to invest in EIS, be either investing directly in a single qualifying company or through a fund structure.
Enterprise Value
The equity value represents the total value of a business, including its debt but excluding its cash. It is a metric used to estimate the fair market value of a company when it is of interest to an acquiror or being considered as part of a merger.
Exit Strategy
An exit strategy is a proactive, structured plan that enables business owners and investors to realise value from their company at the right time. It outlines the optimal route, such as a trade sale, merger, management buyout (MBO), or IPO, and guides decision-making through both positive and negative scenarios. A well-considered exit strategy starts with clear objectives, whether that be maximising financial return, transitioning to a new venture, or securing succession. Ultimately, a strong exit strategy ensures that a business is well positioned to maximise value and transition smoothly at the appropriate time.
G
General Partner
The individual or group responsible for making investments and overseeing a fund’s day-to-day operations. They play an active role in the deal process and are accountable for investment performance. A GP typically sits at the top of the legal structure of a private equity firm, where it directs strategy, fundraising, and corporate governance.
Growth Capital
A form of equity finance invested by private equity firms in businesses with high growth potential, typically targeted at companies with proven business models and meaningful market traction that are seeking to expand, rather than early-stage start-ups. Growth capital is usually provided in exchange for a minority or majority equity stake, with the funding used to support strategic initiatives such as geographic expansion, product development, infrastructure investment, and key hires, all with the aim of achieving long-term, sustainable growth.
H
Hold Period
The duration for which a private equity firm holds an investment before exiting. The hold period depends on a number of variables, most importantly the constitution of the fund making the investment. If it is a conventional ten-year limited partnership, the key determinant of how long it will be before an exit is sought is the stage reached within the ten-year lifespan. These funds can extend slightly beyond ten years, but this provides a useful guide as to when the private equity investor is likely to seek an exit. In contrast, in what is known as a closed, ended fund, such as a venture capital trust listed on the stock market, the timing of an exit is of much less importance. The underlying investor can adopt a long-term perspective. If the business continues to grow and adds shareholder value, there is no pressure to exit; the investor will instead choose to exit at the optimum time to maximise value, rather than being constrained by the fund's lifespan.
Hundred Day Plan
A concept used by private equity firms which sets out the critical steps that are required to be taken following investment into a company to help create a sustainable road map for future growth and set in motion a culture of change and achievement. It is the blueprint which outlines the most urgent value-creation steps a business should take following investment by a private equity backer and provides an effective way for an investor to quickly establish a working relationship with management and ensure that expectations are aligned. The 100 day plan should not be seen as glorified to do list, instead they play an important role in achieving target returns, where an investor will typically be looking for step changes in processes, efficiency, strategy and controls. It is an integral element in helping to deliver operational improvements which give the best chance of achieving a positive investment return.
Hurdle Rate
Also known as the preferred return, a hurdle rate is the minimum rate of return that must be achieved before a General Partner is entitled to start earning carried interest. It ensures managers are only rewarded for meaningful performance rather than settling for mediocre returns and aligns their incentives with investors' goals ensuring that performance fees are only paid when a pre agreed threshold is met.
I
Internal Rate of Return
Measures the annualised return on an investment, factoring in the timing of cash flows, including capital contributions and distributions. It helps assess the profitability of a deal with a high IRR demonstrating value creation targets have been met or exceeded, while a lower IRR can signal underperformance relative to the original investment targets.
J
J Curve
The ‘J curve’, which resembles the letter “J” when plotted graphically, describes the typical pattern of returns for a private equity fund over time. It illustrates the initial investment dip followed by a gradual and then sharper rise in the value of the fund as assets grow in value and are realised.
M
Management Buyout
A transaction in which the current management team purchases the company they manage. It offers the senior leadership team greater control over the business and incentivises them through equity. It is an alternative exit route for vendors, alongside a sale to a trade buyer or an IPO. Typically, the management team undertaking the MBO will hold senior positions in the company, be well embedded in the business, be familiar with making strategic decisions, and possess the skills and experience required to secure investor support. For shareholders, the transaction is not only financially attractive, but it also offers flexibility to accommodate either a full or partial sale of their shareholding.
P
Partial Exit
Also known as a phased exit. A private equity firm retains a smaller equity stake in a company while selling a majority of its shareholdings. This approach allows an investor to generate an early return for its shareholders and derisk their position, while enabling them to benefit from the future growth potential via a subsequent sale of the business. It provides the manager with immediate liquidity to facilitate new investments and pay shareholder dividends, while retaining an economic interest in a business which demonstrating strong growth trajectories and robust market positions.
Portfolio
A collection of financial investments or companies owned by an individual, institution or fund. The composition of a portfolio will differ depending on the owner. For example, an individual investor’s portfolio will typically aim to preserve or grow wealth through traditional assets (such as stocks and bonds) and alternative assets (such as private equity and property). In contrast, a portfolio held by a private equity firm refers to the group of companies in which it has invested. A major part of portfolio management involves diversification across asset classes, stages of growth, sectors and geographies to reduce risk and volatility.
Preference Shares
There are two types of preferences that are commonly used in private equity. The first is a non participating preference, otherwise known as a downside or liquidation preference. It is designed to protect investors in scenarios where the company is sold at a disappointing valuation and one that falls short of stakeholder expectations. In such cases, after any outstanding debt is repaid, the private equity investor’s capital is returned first, ahead of any distributions to other equity holders. Less commonly used is the participating preference, which is typically negotiated at the time of investment. Under this structure, the investor may agree to pay a premium for the business, higher than it might otherwise consider, in exchange for enhanced return rights. This mechanism, often referred to as a 'double dip', allows the investor to recover their initial capital after any debt and then participate in upside gains alongside other shareholders.
Private Equity
Private equity refers to an investment made into privately held companies, typically by specialist firms, institutional investors or family offices. These investors provide capital to support expansion, strategic change or operational improvement, acquiring a stake of the business in the process. Unlike public market investing, private equity involves long term commitments and active ownership, with the aim of enhancing business value ahead of an eventual exit, such as a sale or IPO.
R
Rachet
A tool that a private equity firm can use to help improve the attractiveness of their offer to a management team or existing shareholders. It is a contractual agreement whereby an investor will agree to pay to the management team or other shareholders an excess of proceeds above a hurdle. Those hurdles are typically a twin test. The first test will be the achievement or the exceeding of an internal rate of return and the second will be a money multiple on capital invested. If both those hurdles are achieved, the investor will agree to pay over some of their proceeds to the management team and other shareholders.
Risk Appetite
An investor's willingness to take on risk in pursuit of higher returns, often influenced by factors like age, financial goals, and market conditions. It is a careful balance of risk vs reward and reflects a person’s tolerance for potential losses and their comfort during uncertainty in the pursuit of potential returns.
V
Valuation
Pricing is one of the most important metrics when evaluating an investment in a private company - getting the value right at entry and avoiding overpayment is critical. There are two methodologies for determining a valuation. The first, typically used for more established, profitable, and later-stage businesses, is a multiple of EBITDA. That multiple will depend on the rate of growth, intrinsic value, sector attractiveness, and other metrics that influence an investor's judgement. Alternatively, for a technology or growth business, for example, an investor may apply a multiple of ARR (annual recurring revenue). At this stage, the business is often seeking capital to grow and may still be loss-making, which is precisely why external funding is required to support expansion.
Venture Capital
Venture capital is a form of equity funding, which follows on from seed funding, primarily aimed at early-stage businesses, startups and scaleups. Businesses can receive venture capital funding throughout the early and middle stages of their growth cycle with technology companies some of the most well known VC backed businesses because of their potential to scale rapidly. Venture Capital can be staged over a series of multiple funding rounds, allowing businesses to fundraise as needed.
Venture Capital Trust (VCT)
VCTs are investment companies, similar in structure to Investment Trusts, whose share are listed and traded on the London Stock Exchange. VCTs were introduced in 1995 as a government measure aimed at encouraging private investors to invest in small UK companies, whilst allowing them to benefit from some of the most attractive tax incentives available to UK investors.
Volatility
A measurement of how quickly markets move. It is the degree of variation in the price of a security over time, often used as a measure of risk. The more of a price changes, the greater the volatility, especially if the asset is prone to unpredictable, sharp price movements. All investments have some level of volatility, but generally higher risk / higher return potential is correlated with higher volatility.