While there are no strict definitions of a private equity firm and a hedge fund, some distinct similarities and differences separate the two types of firms.

Private equity firms and hedge funds are similar in that both invest from a leveraged pool of capital normally contributed by limited partners; both compensate the management team based on a percentage of profits (typically 20%) as well as charge a fee on assets under management (typically 2%); and both are lightly regulated (as of this writing).

While some firms do blur the distinction between typical private equity and hedge fund activities by operating with one foot in each camp, the most significant difference between the two types of firms is in is their underlying business model and how they approach their investments.

Private equity firms tend to invest in private companies that are longer-term, ill-liquid assets with the intent to buy, grow and exit these portfolio companies over a three to seven year period. Over the course of an investment, a private equity firm will address capital structure, management team, strategic growth and fundamental business model issues core to the investment.

In contrast, hedge funds primarily focus on investing in more tradable (and therefore usually more liquid) securities such as equities, bonds, derivatives, futures, commodities, foreign exchange, swaps, etc. As such, hedge funds are likely to hold investments for a much shorter duration, sometimes for merely minutes or seconds with no intent to fundamentally alter the course of direction of a direct investment in a company.