Author: Gert-Tom Draisma / www.TristanFinance.com

First published: 24th of September 2026

Latest update: 28th of September 2026

1. Private equity does not have a continuous market

Imagine that an investment manager decides on Monday morning to invest €100 million in a large publicly listed company.

Provided sufficient trading liquidity exists, the investment can begin almost immediately.

The investor does not need to persuade the existing shareholders that they should sell the company.

It does not need to obtain access to a private data room.

It does not need to negotiate a share purchase agreement with the seller.

It does not ordinarily need to investigate title to every subsidiary, review thousands of customer contracts or negotiate representations and warranties merely to acquire an economic interest.

There is already a market.

There are buyers and sellers.

There is an observable price.

There are brokers, exchanges, custodians and clearing systems.

The security is standardised.

Settlement procedures are established.

The investor can buy.

Private equity begins somewhere entirely different.

There is no exchange on which an investment manager can place an order for:

100% of a high-quality European industrial company with €50 million EBITDA.

First, such a company has to exist.

Then it has to be identified.

Its shareholders must be willing to sell.

The manager needs sufficient information to decide whether it is interested.

A price must be negotiated.

Extensive due diligence may be required.

Debt financing may need to be arranged.

Contracts must be negotiated.

Regulatory approvals may be necessary.

Management arrangements may have to be agreed.

And only after all of this does ownership actually change.

Private equity is therefore not merely illiquid.

It is transactionally intensive.

That distinction is fundamental.

2. Illiquidity is not the same as impossibility of sale

The word illiquid can be misleading.

It does not mean that a private equity investment can never be sold before some predetermined date.

As we saw in Part III, sophisticated secondary markets now exist for LP interests. Private-company shares can sometimes be transferred. Portfolio companies can be sold to strategic buyers or other financial sponsors. Continuation vehicles can create liquidity without terminating the manager's ownership of an asset.

Private equity is therefore not characterised by the absolute absence of liquidity.

It is characterised by the absence of:

continuous, guaranteed, low-cost liquidity at a readily observable market price.

Liquidity generally has to be created.

A counterparty has to be found.

Information has to be exchanged.

The asset has to be valued.

Terms have to be negotiated.

Documentation has to be completed.

Sometimes consent is required.

Sometimes financing is required.

Sometimes a discount must be accepted.

And sometimes no transaction can be completed at an acceptable price.

The economically important concept is therefore not:

Private equity cannot be sold.

It is:

Private equity cannot normally be converted into cash on demand at a continuously observable market price without material transaction friction.

3. Illiquidity exists on entry as well as exit

Illiquidity is often discussed as though it begins after an investment has been acquired.

The fund owns a company and cannot sell it tomorrow.

That is true.

But it is only half the story.

Private equity is also illiquid before the investment is made.

A public-market investor can normally choose among thousands of securities available for purchase today.

A private equity manager cannot simply decide:

“We would like to acquire twelve attractive companies this year.”

Those companies must become available.

A founder may spend thirty years building a business and have no intention of selling it.

A family may intend to pass the company to the next generation.

A corporate parent may decide to retain a division.

Another PE sponsor may believe that its portfolio company has several more years of growth ahead.

An attractive business can remain unavailable indefinitely.

Private equity therefore has two distinct liquidity problems:

Can we buy the asset?

and eventually:

Can we sell the asset?

The first is sometimes overlooked.

4. Capital availability and asset availability are different things

This distinction has important consequences for fund management.

Suppose a GP raises a €10 billion fund.

It now has €10 billion of committed capital.

But it does not have €10 billion of attractive investments.

Those still have to be found.

The manager may face pressure to deploy capital because:

• the investment period is finite;
• management fees are being charged;
• LPs expect the strategy to be executed;
• and successor fundraising will eventually depend upon demonstrating investment progress.

Yet investing too quickly can be dangerous.

The existence of capital does not make investments attractive.

This creates one of private equity's recurring tensions:

The fund has been raised to invest, but the manager must retain the discipline not to invest simply because capital is available.

5. Good companies are scarce

Private equity managers compete intensely to raise capital.

Once the fund has been raised, however, the direction of competition changes.

The capital has already been secured.

Managers now compete for assets.

And the companies most attractive to private equity tend to possess characteristics that many investors recognise:

• defensible market positions;
• recurring or predictable revenue;
• attractive margins;
• strong cash conversion;
• capable management;
• limited capital intensity;
• pricing power;
• opportunities for growth;
• fragmented markets suitable for consolidation;
• and credible future exit routes.

A company possessing most of these qualities is unlikely to attract only one interested buyer.

The better the business, the greater the competition can become.

This creates an important paradox:

The companies that are easiest to identify as excellent businesses can be the hardest investments from which to generate exceptional returns because everyone else can see that they are excellent too.

Quality and investment attractiveness are not identical.

Price matters.

6. The acquisition price matters before value creation begins

Suppose two funds buy identical companies.

Fund A pays:

10× EBITDA

Fund B pays:

15× EBITDA

Everything that happens operationally afterward is identical.

The businesses grow at the same rate.

Margins develop identically.

Debt is repaid at the same speed.

Both companies are eventually sold at 12× EBITDA.

The underlying businesses have performed identically.

The investment outcomes will not.

Fund A benefits from multiple expansion.

Fund B suffers multiple contraction.

The price paid on entry therefore establishes the starting conditions from which all subsequent value creation must operate.

A good company can be a bad investment if acquired at the wrong price.

This is one reason transaction discipline is so important.

7. Sourcing

The process of finding investment opportunities is generally called sourcing or origination.

Private equity firms devote substantial resources to it.

Opportunities can arise through:

• investment banks;
• corporate-finance advisers;
• accountants;
• lawyers;
• consultants;
• lenders;
• industry executives;
• founders;
• family shareholders;
• management teams;
• existing portfolio companies;
• other PE firms;
• sector conferences;
• proprietary research;
• and direct approaches.

Some firms maintain dedicated origination teams.

Others expect every investment professional to develop relationships capable of generating opportunities.

Sector-specialist managers may map an industry for years before the company they most want to own becomes available.

Sourcing is therefore not simply about producing a high volume of opportunities.

It is about obtaining access to attractive opportunities on investable terms.

8. The deal funnel

A private equity firm may examine an enormous number of potential transactions compared with the number it ultimately completes.

A stylised annual funnel might look like:

500 opportunities reviewed

↓

150 subjected to meaningful initial analysis

↓

50 discussed seriously

↓

25 indicative offers

↓

10 extensive diligence processes

↓

5 completed investments

The actual numbers differ enormously between firms and strategies.

The principle does not.

The visible portfolio represents only the final output of a much larger selection process.

Hundreds of rejected opportunities disappear from view.

Yet those rejections are part of the investment process.

Private equity performance depends not only upon what the manager buys.

It depends upon what the manager refuses to buy.

9. Selection itself consumes resources

This has an important economic consequence.

Most investment work does not necessarily result in an investment.

Teams can spend weeks analysing a company before rejecting it.

Partners can meet management several times.

External advisers may be engaged.

A preliminary financing package may be discussed with lenders.

Lawyers may review important issues.

And the process can still end with:

No.

From an accounting perspective, this can appear unproductive.

From an investment perspective, it may be exactly what the manager is being paid to do.

The purpose of an investment process is not to maximise the percentage of opportunities that become transactions.

It is to maximise the quality of the transactions that survive.

10. The auction

Many significant private companies are sold through organised auctions.

The seller appoints an investment bank or corporate-finance adviser.

Potential buyers are identified.

A controlled process begins.

At its simplest:

Teaser

↓

Confidentiality agreement

↓

Information memorandum

↓

Indicative offers

↓

Selected bidders

↓

Data-room access and management meetings

↓

Due diligence

↓

Binding offers

↓

Exclusivity

↓

Documentation

↓

Signing and completion

The process temporarily creates something resembling a market around an otherwise privately held asset.

But it remains very different from an exchange.

The market may contain only five credible buyers.

It may exist for three months.

And when the process ends, the market disappears.

11. Why sellers use auctions

The seller has an obvious reason to encourage competition.

Suppose four buyers value a company at:

€800 million€850 million€900 million€1.0 billion

A bilateral negotiation with the first buyer might have produced a transaction around €800 million.

An auction reveals that someone is prepared to pay substantially more.

Competition can also improve non-price terms.

A bidder may:

• reduce conditions;
• provide greater financing certainty;
• accept more seller-friendly documentation;
• move faster;
• or assume greater regulatory risk.

An auction therefore creates competition not only over price, but over certainty and terms.

12. The seller controls information

A well-run auction attempts to control both information and timing.

Initially, prospective buyers may receive a short anonymous teaser.

Those expressing interest sign confidentiality agreements.

They receive an information memorandum.

Indicative offers are requested.

Only selected bidders receive detailed access to the company.

The seller may determine:

• which documents are provided;
• when they are provided;
• when management can be interviewed;
• which questions can be asked;
• and when bids must be submitted.

The buyer is therefore attempting to make an investment decision inside a process largely designed by the seller.

That itself is a form of transaction friction.

13. Exclusivity changes bargaining power

During a competitive process the seller has leverage.

If Buyer A becomes difficult, Buyer B may still exist.

Once one buyer receives exclusivity, that competitive pressure weakens.

The seller therefore wants to maintain competition for as long as possible.

The buyer, by contrast, wants exclusivity as early as possible.

Why spend millions on final due diligence and documentation while another bidder can still take the transaction away?

The timing of exclusivity therefore becomes part of the negotiation.

Even the process through which the transaction is negotiated has economic value.

14. Proprietary transactions

Not every company is sold through an auction.

A PE firm may approach an owner directly.

Perhaps it has known the founder for ten years.

Perhaps it already owns another business in the industry.

Perhaps it has developed a compelling expansion plan.

Perhaps the owner wants a partner rather than simply the highest bidder.

If the parties negotiate without a formal competitive sale process, the transaction may be described as proprietary.

Proprietary sourcing can be attractive because direct price competition may be reduced.

But proprietary does not mean cheap.

A sophisticated owner can obtain valuation advice.

It may introduce competition later.

And without an auction, the buyer itself has less external evidence about where the market would price the company.

Removing competition can reduce one source of friction while increasing another: price uncertainty.

15. Relationships can have economic value

Private equity therefore invests heavily in relationships.

Consider a founder who has spent forty years building a company.

It employs 3,000 people.

The family name is attached to it.

Long-serving employees are personally known to the founder.

Selling the company is not equivalent to selling a block of listed shares.

The founder may care about:

• employees;
• management;
• culture;
• brand;
• future investment;
• reputation;
• and what happens after the transaction.

The highest bidder does not necessarily win.

A PE firm that has built trust over many years may gain access to a transaction that another investor cannot obtain merely by offering more money.

Private markets therefore contain not only financial capital.

They contain relationship capital.

16. Why is the owner selling?

One of the first questions a buyer should ask is deceptively simple:

Why is this company for sale?

Perhaps:

• the founder wants to retire;
• the family needs succession;
• a corporation is disposing of a non-core division;
• the existing PE owner has reached the appropriate point in its fund lifecycle;
• shareholders disagree about strategy;
• the business requires more capital;
• management wants greater ownership;
• or the seller believes the valuation is exceptionally attractive.

The answer matters.

A seller normally knows the company better than the buyer.

The buyer should therefore understand why the person possessing superior information is willing to part with the asset.

This does not mean every seller knows something negative.

It means the motivation deserves investigation.

17. Information asymmetry

At the beginning of a transaction, the seller and management know vastly more about the company than the buyer.

Management has operated the business for years.

The buyer may have seen a fifty-page information memorandum.

The buyer needs information before it can determine whether the company is attractive.

But it must often spend time and money before it receives enough information to make that determination.

This produces a circular problem:

The buyer needs information to know whether an opportunity deserves investigation, but it needs to investigate in order to obtain the information.

The investment process therefore develops in stages.

At each stage, the buyer asks whether the expected value of learning more justifies the cost of continuing.

18. Initial screening

The first stage must be efficient.

Questions may include:

Does the company fit the fund mandate?

Is it large enough?

Is it too large?

Is the geography appropriate?

Do we understand the sector?

Does the business model appear attractive?

Is there a plausible investment thesis?

Is the expected valuation remotely acceptable?

Can the company support the likely financing?

Are there obvious regulatory problems?

Can we imagine a future buyer?

Do we possess a reason to believe we could own this company better than someone else?

If the answer to a fundamental question is no, stopping early is valuable.

There is little merit in spending €2 million proving something that could have been identified in the first week.

19. The indicative offer

In an auction, the buyer may be required to submit an indicative valuation before receiving complete information.

This creates an uncomfortable problem.

Bid too low and the buyer is eliminated.

Bid too high and it may advance in the process only because it has been overly optimistic.

The indicative bid therefore has two purposes.

It expresses a preliminary valuation.

But it also purchases continued access to information.

The buyer is effectively saying:

“Based on what we currently know, we might be willing to pay approximately this amount. Give us enough access to determine whether that remains true.”

20. The winner's curse

Auctions create the possibility of a winner's curse.

Suppose six sophisticated bidders value a company independently:

€720 million€760 million€800 million€825 million€860 million€975 million

The last bidder wins.

Perhaps it has identified a genuine opportunity others have missed.

Perhaps it has superior management.

Perhaps it owns another company that creates unique synergies.

But another possibility exists.

It may simply be the bidder with the most optimistic assumptions.

Private equity therefore requires the discipline to ask:

Are we winning because we understand something that others do not—or because we are wrong?

Winning an auction is not itself evidence of success.

It is the beginning of the investment.

21. Due diligence

If an opportunity survives initial screening, detailed due diligence begins.

Due diligence is the organised attempt to reduce the information asymmetry between buyer and seller.

A major transaction may include:

• commercial due diligence;
• financial due diligence;
• legal due diligence;
• tax due diligence;
• operational due diligence;
• technology due diligence;
• cybersecurity due diligence;
• human-resources due diligence;
• environmental due diligence;
• insurance due diligence;
• regulatory due diligence;
• pension due diligence;
• intellectual-property due diligence;
• and other specialist workstreams.

The exact combination depends upon the business.

A software company creates different risks from a chemicals manufacturer.

A hospital operator requires different expertise from a consumer brand.

There is no universal diligence checklist capable of replacing judgement.

22. Due diligence asks a simple question

The enormous machinery of due diligence can obscure its basic purpose.

The buyer is trying to answer:

What exactly are we buying?

Not merely:

What were last year's earnings?

But:

How sustainable are those earnings?

What assets produce them?

What liabilities accompany them?

What investment will be required to preserve them?

How dependent are they on particular customers?

What happens if key employees leave?

Who owns the intellectual property?

Can the systems support future growth?

Are taxes properly paid?

Could regulation change?

What has management not considered?

The buyer is trying to replace a simplified sale narrative with a sufficiently complete economic understanding of the company.

23. Commercial due diligence

Commercial due diligence examines the market and competitive position.

Questions can include:

How large is the market?

How quickly is it growing?

What drives demand?

What could cause demand to decline?

Who are the competitors?

Why do customers choose this company?

How strong is customer retention?

How sensitive are customers to price?

How sustainable is market share?

Could technology disrupt the industry?

What does the company need to do to achieve management's growth plan?

External consultants may:

• interview customers;
• interview former employees;
• analyse competitors;
• purchase market data;
• model industry growth;
• and test management assumptions.

The purpose is not to produce an impressive report.

It is to establish whether the commercial assumptions supporting the valuation are credible.

24. Financial due diligence

Financial due diligence asks whether reported financial performance accurately reflects the underlying economics of the company.

One central concept is quality of earnings.

Suppose management reports:

EBITDA = €50 million

The buyer asks:

How much is recurring?

Were there exceptional gains?

Are costs missing?

Were expenses capitalised?

Are there owner-related costs that disappear after acquisition?

Are there costs that need to be added?

Have acquisitions distorted comparability?

What is sustainable EBITDA?

The answer matters enormously because valuation is frequently expressed as a multiple of EBITDA.

25. A small EBITDA adjustment can create a large valuation difference

Suppose a company is valued at:

12× EBITDA

The seller claims normalised EBITDA of:

€50 million

Implied enterprise value:

€600 million

The buyer concludes that sustainable EBITDA is only:

€45 million

At the same multiple:

€45 million × 12 = €540 million

A €5 million disagreement over earnings has created a:

€60 million disagreement over value.

This is why apparently technical accounting adjustments can become major commercial negotiations.

26. The quality-of-earnings debate

Seller and buyer may disagree over what constitutes sustainable earnings.

The seller may say:

“This restructuring expense is exceptional.”

The buyer may respond:

“You restructure something every year.”

The seller may say:

“We have already implemented €4 million of cost savings.”

The buyer may respond:

“Only €1 million has actually appeared in the accounts.”

The seller may annualise a newly won customer.

The buyer may discount the value because the contract can be terminated.

The seller may remove losses from a recently closed division.

The buyer may accept that adjustment.

Transaction EBITDA is therefore not always a simple number copied from audited financial statements.

It can become a negotiated representation of the company's sustainable earning capacity.

27. Working capital

Enterprise value is not necessarily the amount paid to shareholders.

Transactions frequently adjust for:

• cash;
• debt;
• debt-like items;
• and working capital.

A company needs a normal level of working capital to operate.

A seller should not be able to increase cash immediately before closing simply by:

• delaying supplier payments;
• aggressively collecting receivables;
• or reducing inventory below sustainable levels.

The parties therefore often establish a normalised working-capital target.

Differences between actual and target working capital can adjust the final equity price.

A headline €500 million acquisition can therefore contain detailed negotiations over individual balance-sheet classifications.

28. Net debt and debt-like items

The simplified bridge is:

Equity Value = Enterprise Value – Net Debt

But what exactly is debt?

Bank loans are obvious.

Other items may be less clear.

Should the calculation include:

• leases?
• overdue tax?
• unpaid bonuses?
• deferred consideration?
• pension deficits?
• factoring?
• supplier finance?
• litigation provisions?
• restructuring liabilities?
• customer advances?

Some items may be treated as debt-like even if accounting standards do not classify them as conventional borrowings.

The enterprise-value-to-equity-value bridge can therefore become another major area of negotiation.

29. Legal due diligence

Legal due diligence examines the rights and obligations attached to the business.

Lawyers may review:

• corporate ownership;
• material contracts;
• financing agreements;
• litigation;
• employment arrangements;
• real estate;
• licences;
• regulation;
• intellectual property;
• data protection;
• environmental matters;
• and change-of-control provisions.

A financially attractive business can contain a legal problem capable of materially changing its value.

A major customer may have a right to terminate following a change of control.

The company may not own software it depends upon.

A licence may be non-transferable.

A subsidiary may face litigation.

A property may contain environmental liabilities.

Financial statements cannot reveal everything that is economically important.

30. Tax due diligence

Tax liabilities can remain with a company after ownership changes.

A buyer therefore needs to understand historical compliance concerning matters such as:

• corporate income tax;
• VAT or sales taxes;
• payroll taxes;
• withholding taxes;
• transfer pricing;
• customs;
• permanent establishments;
• and employee taxation.

Historic structures may be challenged.

Tax losses may not remain usable after the acquisition.

The transaction itself can create tax consequences.

The buyer therefore needs to understand both:

historic tax risk

and:

future tax structure.

31. Technology due diligence

Technology has become central to the economics of many businesses.

Questions include:

Who owns the software?

How old are the systems?

Can they scale?

How much technical debt exists?

Are licences valid?

How dependent is the company on particular developers?

How well are systems integrated?

What investment is required after acquisition?

A company may appear highly profitable because it has systematically underinvested in its technology.

If €40 million must be spent immediately after acquisition to modernise critical systems, the buyer's true economic entry cost is higher than the purchase price suggests.

32. Cybersecurity

Cybersecurity deserves particular attention because historic financial performance may say little about future vulnerability.

A serious breach can create:

• operational disruption;
• regulatory penalties;
• litigation;
• remediation costs;
• customer losses;
• and reputational damage.

The buyer therefore asks not only:

“Has the company been breached?”

but:

“How likely is a serious breach, and what would happen if one occurred?”

This illustrates a broader point.

Due diligence cannot focus only on historic facts.

Private equity invests in the future.

33. Environmental and regulatory diligence

Some risks can remain hidden for years.

A manufacturing site may contain contamination.

A company may depend upon an environmental permit.

A healthcare business may rely upon reimbursement rules.

A financial-services company may require regulatory permissions.

A defence supplier may face export restrictions.

A telecommunications company may operate under licences.

The more regulated the industry, the less meaningful purely financial diligence becomes.

The buyer needs to understand the legal and institutional environment within which future cash flows can be generated.

34. Management due diligence

The buyer is also acquiring a human organisation.

Private equity teams therefore spend substantial time assessing management.

Can management explain the business?

Do the numbers reconcile with the story?

Do executives acknowledge weaknesses?

Are forecasts credible?

Can the company function without the founder?

Is there a capable second layer?

Which executives might leave?

Who makes the real decisions?

Where are organisational bottlenecks?

The difficulty is obvious.

A spreadsheet can be recalculated.

A contract can be read.

Human judgement cannot be audited in the same way.

Management assessment remains one of the least deterministic parts of private equity underwriting.

35. Management may have multiple interests

The position becomes more complicated when management itself benefits economically from the transaction.

Executives may:

• own shares;
• receive transaction bonuses;
• reinvest proceeds;
• become shareholders in the new structure;
• and receive new incentive arrangements.

Management may therefore simultaneously be:

a source of information;

part of the seller group;

and:

the future partner of the buyer.

The buyer must understand those incentives when evaluating information provided during the transaction.

36. The data room

Modern due diligence is generally organised around a virtual data room.

It may contain thousands or tens of thousands of files:

• accounts;
• budgets;
• contracts;
• board minutes;
• tax returns;
• employee records;
• customer data;
• supplier agreements;
• property documents;
• insurance policies;
• litigation files;
• intellectual-property records;
• operational data;
• and technical documentation.

A large transaction can generate an extraordinary volume of information.

The problem is no longer simply obtaining documents.

It is determining:

Which information can materially change the investment decision?

37. Artificial intelligence can reduce information friction

Artificial intelligence is likely to reduce some forms of transaction friction materially.

AI systems can increasingly assist with:

• contract review;
• document classification;
• financial reconciliation;
• anomaly detection;
• market research;
• data-room search;
• customer segmentation;
• and comparison of large bodies of information.

This can reduce the cost and time required to process information.

It can allow investment teams to examine larger datasets than human teams could practically review manually.

But this should not be confused with eliminating investment uncertainty.

The difficult questions remain forward-looking.

Will customers stay?

Will management execute?

Will the market grow?

Will margins improve?

Will competitors respond?

Will the exit market be favourable?

No data room contains those answers.

AI can reduce information-processing friction.

It cannot abolish uncertainty about the future.

38. Due diligence is not a search for certainty

This is an important conceptual point.

A buyer can spend indefinitely on due diligence and still never know everything.

At some point the transaction must either be rejected or completed.

The objective is therefore not certainty.

It is to reduce uncertainty sufficiently to make an informed decision at the proposed price.

A risk can be acceptable at €500 million and unacceptable at €800 million.

Diligence and valuation are therefore inseparable.

The question is not merely:

“Is this a risky company?”

It is:

“Are we being adequately compensated for the risks we are assuming?”

39. The investment thesis

As diligence progresses, the deal team develops an investment thesis.

It explains why the fund should own the company.

The thesis may include:

• attractive market growth;
• market-share opportunity;
• margin improvement;
• pricing;
• international expansion;
• acquisitions;
• management improvement;
• product expansion;
• digitalisation;
• cash generation;
• or another source of value.

A good thesis should also identify what must be true for the investment to succeed.

That makes the thesis testable.

If success requires ten assumptions to be simultaneously correct, the investment may be considerably more fragile than a spreadsheet suggests.

40. The financial model

The investment thesis is translated into a financial model.

The model may project:

• revenue;
• EBITDA;
• capital expenditure;
• working capital;
• cash flow;
• debt;
• interest;
• acquisitions;
• exit valuation;
• and investor returns.

But a model is not the investment.

It is a structured expression of assumptions.

If the assumptions are wrong, mathematical precision does not rescue the answer.

Private equity models can therefore be simultaneously:

highly precise mathematically

and:

highly uncertain economically.

Understanding that distinction is critical.

41. The downside case

Good underwriting asks what happens if the plan fails.

Suppose the base case assumes:

• 8% revenue growth;
• 200 basis points of margin expansion;
• rapid debt repayment;
• and an exit at the entry multiple.

A downside case might assume:

• 2% growth;
• no margin improvement;
• slower debt reduction;
• and multiple contraction.

The questions then become:

Can the company service its debt?

Would additional equity be required?

Does the fund recover its capital?

Could the company survive a recession?

How sensitive are returns to the exit valuation?

The downside case is particularly important because private equity cannot assume it can immediately escape a deteriorating investment by selling it.

42. The investment committee

The deal team generally cannot commit the fund simply because it likes the transaction.

Material investments require approval from an Investment Committee, or IC.

The team presents its case.

Committee members challenge it.

Why will the market grow?

Why is management capable?

Why are margins expected to improve?

Why is customer concentration acceptable?

Why are we paying this multiple?

What happens if interest rates remain higher?

Why is the seller selling?

What would cause us to lose money?

What does the seller understand that we do not?

What do we understand that competing bidders do not?

The investment committee exists partly to introduce distance between the people who have become immersed in the transaction and the decision to commit capital.

43. Deal momentum

This distance matters because transactions develop momentum.

A team may have worked on an acquisition for six months.

It has:

• built models;
• travelled;
• met management;
• instructed advisers;
• negotiated with lenders;
• competed through several auction rounds;
• and spent millions on diligence.

The team wants to win.

The transaction begins to acquire psychological weight.

Walking away feels increasingly like failure.

This is dangerous.

The fact that enormous effort has already been spent says nothing about whether the next euro should be invested.

44. Sunk costs

The economics are straightforward.

Money already spent cannot be recovered.

It should not determine whether the acquisition should proceed.

Yet the sunk-cost fallacy is powerful.

Private equity creates ideal conditions for it.

There are:

• professional reputations;
• adviser relationships;
• management expectations;
• competitive instincts;
• months of work;
• and substantial expenses.

A disciplined investment culture must therefore permit someone to say:

“We have spent €5 million and nine months on this transaction. We should stop.”

That can be evidence of excellent judgement rather than failure.

45. The cost of saying no

Suppose a fund spends €3 million investigating a company and then abandons the transaction.

No asset has been acquired.

The €3 million is gone.

But suppose diligence revealed a liability capable of destroying €200 million of equity value.

The decision not to invest may have been extremely valuable.

Some of the most valuable work in private equity therefore produces no asset, no press release and no realised gain.

It produces an avoided loss.

That value is invisible.

46. Broken deals are normal

Some transactions will fail.

That is inevitable.

A fund may spend substantial amounts on an acquisition that never completes because:

• diligence reveals a problem;
• valuation cannot be agreed;
• financing changes;
• another bidder wins;
• regulation intervenes;
• management leaves;
• or the seller withdraws.

A private equity process in which every seriously investigated transaction ultimately completed would be concerning.

It could imply that diligence had become a process for justifying decisions already made.

The possibility of walking away must remain real.

47. The cheapest mistake may be a broken deal

Suppose a fund intends to invest:

€500 million of equity

and has already spent:

€5 million

on diligence.

Immediately before signing, a major problem emerges.

Walking away crystallises a €5 million cost.

Proceeding because the €5 million has already been spent could expose the fund to a €500 million mistake.

The relevant comparison is therefore not:

€5 million versus zero.

It is:

€5 million versus the expected loss from proceeding.

Broken-deal costs can be understood partly as the cost of maintaining the ability to reject a bad investment.

48. Price is not the only transaction term

Public markets encourage investors to think primarily in terms of price.

Private transactions contain many other economically important terms.

Two bidders offering the same nominal enterprise value may not be offering equivalent transactions.

Differences can include:

• financing certainty;
• conditionality;
• regulatory risk;
• warranties;
• indemnities;
• escrow;
• deferred consideration;
• earn-outs;
• rollover equity;
• closing timetable;
• and treatment of identified liabilities.

A seller may rationally accept a lower headline price from a buyer offering much greater certainty.

Private equity transactions compete on:

price + terms + certainty + speed.

49. Financing certainty

Leveraged acquisitions introduce another important friction.

The buyer may need substantial debt financing.

The seller wants to know that the buyer can complete.

It does not want to grant exclusivity for months only to discover that the buyer's banks will not provide the money.

The sponsor therefore coordinates:

• equity commitments;
• debt financing;
• lender diligence;
• debt documentation;
• acquisition documentation;
• and completion mechanics.

The financing workstream runs simultaneously with other diligence.

A major private equity acquisition is therefore not one transaction process.

It is several interdependent processes moving toward the same closing date.

50. The purchase agreement

Eventually commercial agreement must become legal agreement.

In a share acquisition, the principal document may be a Share Purchase Agreement, or SPA, although terminology differs between jurisdictions and structures.

The agreement establishes matters such as:

• what is being sold;
• the purchase price;
• price-adjustment mechanisms;
• conditions to completion;
• representations or warranties;
• covenants;
• indemnities;
• liability limitations;
• termination rights;
• and dispute mechanisms.

The SPA performs an important economic function.

It allocates risks that cannot be eliminated through due diligence.

51. Warranties and representations

The seller may make contractual statements concerning the company.

For example:

• accounts have been properly prepared;
• taxes have been paid;
• material contracts are valid;
• assets are owned;
• there is no undisclosed litigation;
• intellectual property is properly owned or licensed.

If these statements prove false, the buyer may have contractual remedies, subject to negotiated limitations.

But warranties are not a substitute for diligence.

A claim can be:

• capped;
• excluded;
• time limited;
• disputed;
• difficult to prove;
• or economically impossible to recover.

The first objective remains to understand what is being purchased before purchasing it.

52. Warranty and indemnity insurance

Modern transactions increasingly use Warranty and Indemnity insurance, often called Representation and Warranty insurance in the United States.

An insurer assumes specified risks associated with breaches of contractual warranties.

This can be particularly useful when the seller is another PE fund.

The selling fund generally wants to distribute proceeds rather than retain large contingent liabilities for years.

Insurance can facilitate a cleaner exit.

But risk has not disappeared.

It has been transferred subject to:

• policy limits;
• exclusions;
• deductibles;
• underwriting;
• and disclosure requirements.

53. Locked-box pricing

One common pricing mechanism is the locked box.

The equity price is established by reference to an agreed historical balance sheet.

The economic benefit of the business effectively passes to the buyer from the locked-box date, subject to the transaction terms.

The seller generally undertakes not to extract value from the company between that date and completion except for agreed permitted leakage.

The attraction is price certainty.

The parties do not need to determine the final purchase price through post-completion accounts.

But the mechanism requires confidence in the locked-box financial information.

Again, diligence and transaction structure are connected.

54. Completion accounts

An alternative is completion accounts.

The final price is determined by reference to financial information prepared as of completion.

A provisional amount may be paid initially.

Subsequent adjustments are then made for matters such as:

• cash;
• debt;
• working capital;
• and other agreed items.

This can provide a more current economic picture.

But it creates less certainty at signing and can generate post-closing disputes.

Neither mechanism is inherently superior.

They allocate transaction risk differently.

55. Signing and completion are not always the same event

Some transactions sign and complete simultaneously.

Others do not.

The parties may sign a binding agreement while ownership transfers only after specified conditions have been satisfied.

These can include:

• competition approval;
• foreign-investment approval;
• sector regulation;
• shareholder approval;
• financing requirements where applicable;
• or other conditions precedent.

During this period the seller still owns a company it has agreed to sell.

The buyer has agreed to acquire a company it does not yet control.

The business itself continues operating.

A new category of risk therefore exists between signing and completion.

56. Regulatory friction

Regulatory approvals have become increasingly important as private equity transactions have become larger and more international.

A transaction may require review under:

• competition law;
• foreign-direct-investment regimes;
• national-security rules;
• financial-services regulation;
• healthcare regulation;
• telecommunications regulation;
• or other sector-specific systems.

A multinational transaction may require approvals in numerous jurisdictions.

This affects:

• timing;
• cost;
• certainty;
• and sometimes price.

A buyer capable of assuming more regulatory risk may be more attractive to the seller even if another bidder offers slightly more money.

57. Execution risk

A transaction is not complete until it completes.

Between initial interest and ownership, many things can change.

The buyer may discover a problem.

Financing markets may deteriorate.

A regulator may intervene.

Another bidder may emerge.

Trading may weaken.

A major customer may leave.

Management may resign.

A geopolitical event may occur.

The longer the process continues, the more opportunity exists for circumstances to change.

Private equity managers therefore require not only investment judgement.

They require execution capability.

58. The human infrastructure of a transaction

A large acquisition can involve an extraordinary number of people.

On the buyer side:

• partners;
• principals;
• associates;
• analysts;
• operating professionals;
• financing specialists;
• internal lawyers;
• tax professionals;
• external lawyers;
• accountants;
• commercial consultants;
• technology specialists;
• environmental specialists;
• insurers;
• and lenders.

The seller has its own advisers.

Management has advisers.

Lenders have lawyers.

Regulators may become involved.

A single acquisition can mobilise hundreds of people.

This is the opposite of frictionless investing.

59. Transaction costs

All this activity costs money.

Beyond the purchase price, an acquisition can incur:

• investment-banking fees;
• legal fees;
• accounting fees;
• commercial diligence fees;
• financing fees;
• insurance premiums;
• specialist consulting fees;
• regulatory expenses;
• taxes;
• and other transaction costs.

The precise accounting and allocation differ by transaction and fund.

Economically, however, the point is simple.

The investment must ultimately earn a return not merely on the headline equity purchase price but on the total resources consumed to create the investment.

60. Friction raises the economic break-even point

Consider a simplified comparison.

Public investment

An investor purchases €100 million of a liquid listed security with negligible transaction costs.

If the value rises to €101 million, the investor is economically ahead.

Private investment

A PE fund invests €100 million of equity but incurs €5 million of transaction-related economic costs.

Its total outlay is effectively €105 million.

Before considering subsequent expenses or the time value of money, the investment must create €5 million merely to recover that economic starting position.

Exit will create another set of costs.

Private equity therefore begins each investment with friction that must ultimately be overcome.

61. Time is also a transaction cost

Not every cost appears on an invoice.

Suppose two senior partners spend nine months on a transaction that ultimately fails.

Their salaries would have been paid anyway.

The accounting system may therefore show only the external broken-deal expenses.

Economically, however, those partners could have spent nine months pursuing other opportunities.

The same applies to:

• deal teams;
• operating partners;
• financing specialists;
• tax professionals;
• internal lawyers;
• and management.

Private equity consumes attention as well as money.

And senior attention is scarce.

62. Why private equity invests heavily in talent

This helps explain why private equity firms compete aggressively for skilled professionals.

A relatively small number of decisions can have enormous economic consequences.

Suppose better judgement causes a team to avoid overpaying by €100 million.

Or identifies a liability that prevents a €300 million loss.

Or discovers an opportunity others have misunderstood.

Or negotiates a structure that materially improves downside protection.

The value associated with judgement can dwarf the direct cost of the people making the decision.

Private equity is therefore human-capital intensive partly because the underlying market is frictional.

If every asset were perfectly transparent and continuously priced, many of these functions would have much less value.

63. Completion does not end uncertainty

After six months of diligence, the buyer might appear to understand the company extremely well.

Then it becomes the owner.

And discovers how much it still does not know.

Employees behave differently after the transaction.

Management strengths and weaknesses become clearer.

Internal systems reveal limitations.

Customer relationships are understood more deeply.

Operational problems that appeared minor become important.

Information that was technically available before completion acquires different meaning once the buyer is responsible for the consequences.

Due diligence therefore reduces information asymmetry.

It does not eliminate it.

64. Ownership creates a different information position

Before acquisition, the buyer is an outsider asking questions.

After acquisition, it can:

• appoint directors;
• establish reporting;
• speak directly with management;
• inspect operational information;
• change systems;
• recruit executives;
• and influence strategy.

Control therefore changes not only what the investor can do.

It changes what the investor can know.

This is one reason private equity underwriting continues after the acquisition.

The investment thesis must constantly be compared with what actual ownership reveals.

65. The first hundred days

Many sponsors develop a programme for the initial period after acquisition, often loosely called a 100-day plan.

The precise number of days is not important.

The principle is.

Priorities may include:

• establishing reporting;
• confirming management responsibilities;
• improving cash visibility;
• recruiting executives;
• beginning procurement initiatives;
• launching strategic projects;
• addressing urgent operational issues;
• or preparing acquisitions.

Before completion, the question was:

Should we buy this company?

After completion, it becomes:

Now that we own it, what must happen?

The detailed answer belongs in the later Part on value creation.

For now, the important point is that transaction friction does not disappear at closing.

It changes form.

The other side of illiquidity: getting out

66. Buying is only half the transaction problem

A private equity investment does not succeed because the fund acquired a company.

Ultimately, value has to be realised.

That means much of the transaction machinery must eventually operate again in reverse.

The sponsor must:

• decide whether to sell;
• prepare the company;
• identify potential buyers;
• provide information;
• survive buyer due diligence;
• negotiate valuation;
• negotiate documentation;
• obtain approvals;
• and complete the transaction.

Private equity therefore experiences transaction friction twice:

on entry

and:

on exit.

67. Exit begins before the sale process

A sophisticated owner thinks about eventual exit long before appointing an investment bank.

Future buyers will investigate many of the same issues the sponsor investigated at acquisition.

Are the accounts reliable?

Is management strong?

Are contracts documented?

Is intellectual property properly owned?

Are systems scalable?

Are tax affairs clean?

Are customer relationships robust?

Are environmental issues resolved?

Can the growth story survive independent scrutiny?

An unresolved issue can reduce the buyer universe.

Resolving it can therefore create value even if it does not immediately increase EBITDA.

Making a company easier to buy can itself be economically valuable.

68. Exit readiness

This idea can be called exit readiness.

A company with:

• clean financial information;
• strong management;
• robust systems;
• clear legal ownership;
• documented processes;
• predictable cash flow;
• and a credible strategic story

is easier for another investor to underwrite.

Lower perceived transaction risk can:

• increase bidder participation;
• reduce diligence concerns;
• shorten the process;
• improve financing availability;
• and increase certainty.

The sponsor can therefore create value partly by reducing the transaction friction faced by the next owner.

69. Vendor due diligence

A seller may commission its own due diligence before launching a sale.

This is commonly called vendor due diligence.

Independent advisers investigate the company and prepare reports that can be provided to bidders.

The seller can thereby:

• identify problems before buyers discover them;
• prepare explanations;
• improve information quality;
• reduce duplicated work;
• accelerate the auction;
• and increase bidder confidence.

Vendor diligence does not remove the buyer's responsibility to perform its own analysis.

But it can reduce informational friction.

The seller spends money to make the asset easier to buy.

70. The buyer universe

The sponsor and its advisers consider who might purchase the company.

Potential buyers can include:

• strategic corporations;
• other private equity funds;
• family offices;
• sovereign investors;
• long-duration investment vehicles;
• infrastructure funds where appropriate;
• and public-market investors through an IPO.

Different buyers can assign different values to the same business.

The question is therefore not merely:

What is this company worth?

It is also:

To whom is this company worth the most?

71. Strategic buyers

A corporate buyer may be willing to pay more than a financial investor because combining the businesses creates synergies.

Perhaps duplicated costs can be removed.

Perhaps products can be cross-sold.

Perhaps factories can be consolidated.

Perhaps the target provides access to a new geography.

Suppose a company is worth €800 million as a standalone business.

A strategic buyer believes the combination can generate substantial additional cash flow.

It may rationally pay more than €800 million.

Part of the synergy value can therefore be captured by the seller through the transaction price.

72. Secondary buyouts

Another private equity fund may buy the company.

This is generally referred to as a secondary buyout.

At first sight this can seem puzzling.

If the first PE owner has already created value, why should another PE fund want to own the company?

Because there may be several successive investment theses.

The first sponsor may have:

• professionalised management;
• expanded domestically;
• improved margins;
• and completed small acquisitions.

The next sponsor may see opportunities for:

• international expansion;
• a larger acquisition programme;
• digitalisation;
• product expansion;
• or a different organisational structure.

Private equity ownership is not necessarily a one-time transformation.

A company can pass through several stages of institutional ownership.

73. Secondary buyout is not the same as an LP secondary

Terminology can become confusing here.

A secondary buyout means that one private equity-backed company is sold to another private equity fund.

The underlying portfolio company changes owner.

An LP secondary transaction, discussed in Part III, means that an investor sells its interest in a private equity fund to another investor.

The underlying portfolio companies generally remain exactly where they were.

These are economically different transactions.

The word secondary merely indicates that an existing private-market interest is being transferred.

It does not describe one single market.

74. The IPO

An Initial Public Offering, or IPO, provides another route to liquidity.

The company becomes publicly listed.

Instead of finding one purchaser for the entire business, ownership can be distributed across public-market investors.

But an IPO does not necessarily produce a complete exit.

The sponsor may sell only part of its stake.

Remaining shares can be subject to lock-ups.

The sponsor may sell down gradually over subsequent months or years.

An IPO therefore changes the nature of the liquidity problem.

A previously private investment progressively becomes a publicly tradeable one.

75. Dual-track processes

A sponsor can sometimes pursue a sale and IPO simultaneously.

This is known as a dual-track process.

Why incur the cost of preparing two alternatives?

Because optionality has value.

If private buyers offer insufficient value, the IPO may remain available.

If public markets deteriorate, a strategic or financial buyer may provide an alternative.

A credible second route reduces dependence upon the first.

This illustrates a broader principle:

Liquidity improves when the owner has alternatives.

76. Dividend recapitalisation

A company can sometimes generate liquidity without being sold.

Suppose the business has grown and reduced debt.

It may be able to borrow additional money and distribute the proceeds to shareholders.

This is a dividend recapitalisation.

The fund receives cash while retaining ownership.

This can return part—or in some cases a substantial proportion—of the original equity investment before final exit.

But a dividend recap does not eliminate investment risk.

Debt has increased.

The company still needs to perform.

The fund still needs an eventual exit.

Liquidity has been created through financing rather than through transfer of ownership.

77. Continuation vehicles

As discussed in Part III, a continuation vehicle creates another route.

An ageing fund may transfer one or more portfolio companies to a new vehicle managed by the same sponsor.

Existing LPs may obtain liquidity.

Others may continue their exposure.

New secondary capital enters.

This demonstrates why the statement:

“Private equity can only obtain liquidity by selling the company to an unrelated third party”

is no longer correct.

Modern private markets contain multiple mechanisms for creating liquidity.

But continuation vehicles also demonstrate that liquidity can create new conflicts, particularly around valuation and the manager's position on both sides of the transaction.

78. The exit window can close

The existence of multiple exit routes does not mean one is always available on acceptable terms.

Market conditions can change rapidly.

Debt financing can disappear.

Strategic buyers can become defensive.

IPO markets can close.

Valuation expectations can diverge.

A company that appeared readily saleable six months earlier may suddenly have no buyer at the expected valuation.

The sponsor then has a choice:

sell at a lower price

or:

wait.

This ability to wait can be valuable.

But waiting has a cost.

79. The private-market bid-ask spread

Public markets visibly display differences between bids and offers.

Private markets have a bid-ask spread too.

It is simply less visible.

Suppose the sponsor believes its company is worth:

€1.0 billion

Potential buyers offer:

€800 million.

No transaction occurs.

The company remains in the portfolio.

The absence of a transaction does not prove that the sponsor's €1 billion valuation is correct.

Nor does it necessarily prove that €800 million represents long-term economic value.

It demonstrates that buyer and seller have not agreed upon a clearing price.

Private markets can therefore postpone price discovery.

80. Illiquidity can make valuations appear smoother

A listed company can lose 20% of its quoted value in one day.

A privately held company does not produce such a visible price movement because nobody is continuously bidding for it.

Its valuation may be updated quarterly.

Valuation models may use:

• comparable companies;
• transaction multiples;
• discounted cash flow;
• company performance;
• and other evidence.

Private-market valuations can therefore appear smoother than public-market prices.

But economic value itself is not necessarily smoother.

Part of the apparent stability results from infrequent price discovery.

This distinction becomes important when comparing private and public investment performance.

81. Valuation is not realisation

Suppose a fund values a portfolio company at €600 million.

The methodology is reasonable.

Comparable companies support it.

The auditor accepts the valuation process.

The investment committee agrees.

The company remains worth €600 million in the fund's reporting.

But until a buyer actually pays €600 million, that number remains an estimate.

This is the fundamental distinction between:

unrealised value

and:

realised value.

Private equity eventually needs cash.

A valuation can measure estimated progress.

Only a realisation converts that estimate into distributable proceeds.

82. Time has economic value

Suppose a fund expects to sell a company for €1 billion in year five.

Market conditions are poor.

It waits until year seven and ultimately receives the same €1 billion.

The nominal exit value is unchanged.

The investment outcome is not.

Two additional years have passed.

Capital remained tied up.

LP distributions were delayed.

The manager devoted more attention to the company.

The annualised return is lower.

Time is therefore itself part of private equity economics.

The same euro received earlier is worth more than the same euro received later.

83. Optionality has economic value

This is why the ability not to sell can be valuable.

Suppose market conditions temporarily deteriorate.

A forced seller must accept whatever price the market offers.

A patient owner can wait.

The closed-ended private equity fund was designed partly to provide this ability.

LPs cannot ordinarily demand redemption simply because markets become difficult.

The GP therefore has time to avoid selling assets into temporarily weak markets.

Illiquidity, paradoxically, can protect long-term investment strategy.

It is a constraint on LPs.

But it can also be an advantage at portfolio level.

84. Forced sellers are weak sellers

The opposite is equally important.

If the market knows that a sponsor must sell, bargaining power shifts toward buyers.

The fund may be approaching the end of its life.

Lenders may be applying pressure.

The company may require urgent capital.

Regulation may require disposal.

LPs may be demanding liquidity.

Whatever the reason, a deadline reduces optionality.

A seller that can credibly say:

“We are perfectly comfortable continuing to own this company.”

is in a stronger negotiating position than one that must complete before year-end.

Liquidity and bargaining power are therefore closely connected.

85. Distressed investments demonstrate illiquidity most clearly

Transaction friction becomes particularly severe when an investment performs badly.

Potential buyers know the seller may be under pressure.

Lenders may have significant control.

Management can become distracted.

Employees may leave.

Suppliers may tighten terms.

Customers may become nervous.

The company may require additional capital simply to survive.

The sponsor can find itself negotiating simultaneously with:

• management;
• lenders;
• bondholders;
• suppliers;
• potential buyers;
• and other stakeholders.

A company that was difficult to acquire when healthy can become vastly more difficult to sell when distressed.

86. There may simply be no acceptable buyer

This is perhaps the purest expression of private-market illiquidity.

The sponsor can believe a company is worth €500 million.

Its valuation adviser can agree.

Comparable-company analysis can support the number.

The auditor can accept the methodology.

Yet nobody may be prepared to pay €500 million.

The sponsor can either:

• accept less;
• continue holding;
• restructure the investment;
• seek another liquidity mechanism;
• or wait for conditions to change.

There is no exchange guaranteeing that an executable price will exist today.

Why friction can itself create opportunity

87. Friction is not purely a disadvantage

If every private company could be analysed perfectly, priced continuously and purchased instantly by every investor, competition would eliminate many opportunities.

Private markets are interesting partly because they are imperfect.

A company may be:

• difficult to understand;
• poorly managed;
• family owned;
• undergoing succession;
• too small for large funds;
• too complex for strategic buyers;
• geographically fragmented;
• carved out of a larger group;
• difficult to finance;
• or operationally weak.

Many investors may conclude:

Too difficult.

A specialist investor may conclude:

We know how to solve this.

The friction discouraging one investor can create the opportunity for another.

88. Corporate carve-outs

Consider a corporation selling a non-core division.

The division may have:

• no standalone IT system;
• shared employees;
• shared factories;
• no independent treasury;
• intercompany contracts;
• shared intellectual property;
• and financial statements that have never existed independently.

Many buyers dislike the complexity.

A PE firm experienced in corporate carve-outs may understand how to separate the business.

It may therefore acquire the company at an attractive valuation.

Five years later the business has:

• independent systems;
• standalone management;
• clean accounts;
• separate contracts;
• and a coherent strategy.

The next buyer is purchasing a much easier asset.

Part of the value creation has come from removing complexity and transaction friction.

89. Specialist knowledge reduces perceived risk

The same principle applies to sector expertise.

A healthcare specialist may understand reimbursement risk better than a generalist.

A software specialist may understand customer retention and recurring revenue.

An industrial investor may understand manufacturing economics.

A financial-services investor may understand regulatory capital.

A generalist may require a large risk discount because a company appears complicated.

A specialist may determine that the apparent risk is manageable.

It can therefore pay more than less-informed bidders while still expecting an attractive return.

Information can create an edge.

90. Certainty can create an edge

Suppose a seller receives:

Offer A: €1.00 billion

but Buyer A:

• requires extensive additional diligence;
• has uncertain financing;
• needs difficult regulatory approvals;
• and demands broad conditions.

Buyer B offers:

€970 million

but:

• knows the industry;
• has committed financing;
• requires limited additional work;
• and can close quickly.

Which offer is worth more?

There is no universal answer.

The headline price favours Buyer A.

The probability-weighted economic outcome may favour Buyer B.

A reputation for transaction certainty can therefore have monetary value.

91. Speed can create an edge

The same applies to speed.

A corporation may need to dispose of an asset before its financial year-end.

A founder may want certainty.

A distressed seller may need immediate capital.

A regulator may impose a deadline.

A buyer that can move rapidly may obtain access or economics unavailable to slower competitors.

This is why institutional infrastructure matters.

Experienced:

• investment professionals;
• lawyers;
• tax specialists;
• financing teams;
• operating professionals;
• and investment committees

can make the organisation faster without necessarily making it less rigorous.

Execution capability can become a source of competitive advantage.

92. Friction helps explain return dispersion

If private equity transactions were standardised and frictionless, managers would have fewer opportunities to differentiate themselves.

But they are not.

One manager may source an opportunity another never sees.

One may understand the industry better.

One may identify a risk another misses.

One may negotiate a better price.

One may arrange more resilient financing.

One may reject an investment another buys.

One may attract better management.

One may prepare a company more effectively for sale.

One may identify the best buyer.

Differences in process can therefore create differences in investment outcome.

Manager skill matters partly because private markets are imperfect.

93. Technology can reduce friction without eliminating it

Technology will continue to change the private equity process.

Data rooms become more searchable.

Financial information becomes more standardised.

AI can analyse contracts and large datasets.

Deal sourcing can become more systematic.

Portfolio reporting can become more immediate.

Secondary markets can become more efficient.

But some sources of friction are structural.

A founder still has to decide whether to sell.

A buyer still has to decide what the company is worth.

Management still needs to be assessed.

Future performance remains uncertain.

Control rights need to be negotiated.

Regulators can intervene.

Financing conditions change.

And eventually another party must be willing to provide liquidity.

Technology can reduce transaction friction.

It cannot turn unique private companies into fungible securities.

94. Why there cannot be a perfect exchange for control investments

Could a future platform make private equity as liquid as public equities?

Some elements can certainly become more liquid.

LP interests can trade more efficiently.

Private-company minority shares can trade more frequently.

Information can be standardised.

Settlement can become faster.

But a controlling investment in a private company remains fundamentally different from buying a standardised security.

Buying control means acquiring a unique organisation.

No two companies have identical:

• management;
• employees;
• customers;
• contracts;
• assets;
• tax histories;
• technologies;
• liabilities;
• cultures;
• and strategic possibilities.

The asset itself is non-standard.

That places a natural limit on how frictionless the market can become.

95. Illiquidity is structural rather than accidental

We can therefore refine the concept.

Private equity is not illiquid simply because nobody has yet built the correct exchange.

Its illiquidity arises from the characteristics of the underlying assets.

Each company is different.

Each seller has different objectives.

Information is private.

Control is negotiated.

Financing is transaction-specific.

Legal rights must be investigated.

Management matters.

Regulation matters.

Ownership transfers require documentation.

Exit requires another party willing to assume ownership.

Illiquidity is therefore embedded in the economic nature of private-company control investing.

96. Illiquidity and secondary liquidity can coexist

This does not conflict with the secondary-market developments discussed in Part III.

Both statements can be true:

Private equity is structurally illiquid.

and:

Private equity has increasingly sophisticated secondary markets.

The secondary market does not abolish illiquidity.

It provides mechanisms for transferring illiquid exposure.

An LP can sell its fund interest without forcing the GP to sell every underlying company.

A continuation vehicle can provide liquidity to existing investors while allowing ownership of a company to continue.

A private-company shareholder may sell to another private investor.

These innovations make the asset class more flexible.

But they still depend upon:

• negotiated price;
• information;
• counterparties;
• documentation;
• and time.

Private-market liquidity remains transactional rather than continuous.

97. Liquidity exists at several levels

It is therefore useful to distinguish several different forms of liquidity.

Portfolio-company liquidity

Can the fund sell the underlying company?

Fund-interest liquidity

Can an LP sell its interest in the fund?

GP-led liquidity

Can existing LPs receive liquidity while the manager continues owning the asset through another vehicle?

Financing liquidity

Can cash be generated through recapitalisation or fund-level borrowing without selling the asset?

These mechanisms solve different problems.

They should not be treated as economically equivalent.

A fund can generate cash without realising an investment.

An LP can exit without the portfolio company being sold.

A portfolio company can be sold while the LP remains invested in the rest of the fund.

There is therefore no single event called “private equity liquidity”.

98. The modern definition of private equity illiquidity

A more precise definition can now be given.

Private equity illiquidity is the absence of continuous, standardised and reliably executable liquidity at an observable market price, combined with the time, information, negotiation, cost and uncertainty required to create a transaction.

This definition accommodates both realities.

Private equity interests can be sold.

But selling them is not equivalent to pressing a button on an exchange.

The distinction is one of degree, structure and friction, not absolute possibility.

99. Transaction friction explains much of the private equity model

We can now see why so many characteristics of private equity exist.

Why does the manager need committed capital?

Because acquisition opportunities cannot wait for the manager to begin fundraising after a transaction has been agreed.

Why are funds long-dated?

Because buying, developing and selling private companies takes time.

Why are investment teams expensive?

Because selecting and executing investments requires specialist judgement.

Why are portfolios relatively concentrated?

Because each transaction consumes capital and organisational attention.

Why is due diligence extensive?

Because reversing a bad acquisition is difficult.

Why is governance important?

Because the investor owns and controls the company rather than merely trading its shares.

Why do exit conditions matter?

Because unrealised valuation does not itself create liquidity.

Many apparently separate characteristics of private equity are therefore consequences of one underlying fact:

Private ownership is difficult to enter, difficult to transfer and expensive to unwind.

100. Friction changes the meaning of a mistake

A public investor that changes its mind can often sell.

It may suffer a loss.

But the position can generally be closed.

A private equity fund may not have that option.

Suppose six months after acquisition the sponsor concludes:

We were wrong.

The company may not be immediately saleable.

Potential buyers may ask why it is being sold so quickly.

The debt financing may contain restrictions.

Transaction costs have already been incurred.

Management may have been changed.

The market may have moved.

A rapid resale could crystallise a severe loss.

The difficulty of correcting a mistake increases the value of avoiding the mistake in the first place.

This is one of the most important consequences of illiquidity.

101. Private equity therefore front-loads judgement

Because mistakes are difficult to reverse, private equity invests heavily in decision-making before ownership begins.

That is why so much effort is devoted to:

• sourcing;
• screening;
• valuation;
• diligence;
• investment committees;
• financing;
• negotiation;
• and transaction structuring.

The cost can appear excessive when compared with purchasing a public security.

But the comparison misses the fundamental difference.

The public investor can continuously reconsider its position.

The private equity investor is deliberately entering an ownership relationship from which immediate escape may be expensive or impossible.

The decision threshold should therefore be different.

102. Illiquidity can be both a cost and a source of return

We can now see the dual character of illiquidity.

It is a cost because:

• transactions are expensive;
• capital is tied up;
• mistakes are difficult to reverse;
• valuation is uncertain;
• and exits cannot be guaranteed.

But it can also create opportunity because:

• complexity discourages competitors;
• patient capital can wait;
• specialist knowledge can reduce uncertainty;
• operational improvements can reduce future transaction friction;
• and forced selling can sometimes create attractive entry prices.

Private equity does not merely tolerate illiquidity.

Its economic model partly exists because illiquidity creates problems that specialist capital can sometimes solve profitably.

103. The fundamental trade

The private equity investor therefore accepts something unusual.

It gives up:

immediate liquidity

in exchange for the opportunity to obtain:

control, information, influence and potentially superior long-term economics.

The LP makes a similar trade at the fund level.

It commits capital to a long-dated structure and gives the manager substantial discretion.

In return, it seeks access to investments and capabilities that are not available through continuously traded public markets.

Illiquidity is therefore not simply an unfortunate side effect of private equity.

It is part of the economic bargain.

104. From transaction friction to cash-flow timing

We have now established two fundamental characteristics of the private equity model.

Part III explained the fund structure:

LPs commit capital to a long-dated vehicle, capital is called over time, investments are acquired, assets are eventually realised and proceeds are distributed.

Part IV has explained the friction surrounding those investments:

capital cannot be deployed instantaneously, acquisitions take time and money, portfolio companies cannot necessarily be sold when desired, and realised cash tends to arrive substantially later than the costs and capital required to create the investments.

Those two characteristics interact.

A fund is formed before its portfolio exists.

Fees and expenses begin before most investment gains have been realised.

Capital is called as investments are made.

Companies require time to develop.

Valuations may increase before cash is returned.

And meaningful distributions often arrive only later in the fund's life.

The result is a distinctive pattern in private equity cash flows and reported performance.

That pattern is important enough not to treat merely as a subsection of fund mechanics or illiquidity.

It deserves a Part of its own.

Part V — The J-Curve

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