Many start-up firms require substantial capital. A firm's founder may not have sufficient funds to finance these projects alone, and therefore must seek outside financing. Entrepreneurial firms that are characterized by significant intangible assets, expect years of negative earnings, and have uncertain prospects are unlikely to receive bank loans or other debt financing. Similarly, troubled firms that need to undergo restructurings may find external financing difficult to raise. Private equity organizations finance these high-risk, potentially high reward projects. They protect the value of their equity stakes by undertaking careful due diligence before making the investments and retaining powerful oversight rights afterwards.
Typically, these investors do not primarily invest their own capital, but rather raise the bulk of their funds from instituions and individuals. Large institutional investors, such as pension funds and university endowments, are likely to want illiquid long-run investments such as private equity in their portfolio.
