Before private equity was solely available for specific individuals, the people that could take advantage of this investment were relatively minor, or we could have unique characteristics.
But now, it has opened its doors, giving access to individual investors. You have heard that investing in private equity is one of the best ways to diversify your portfolio, but the big question is why private equity?
What’s so special about it, and why should you invest in private equity? Having got a firsthand experience with this investment strategy and how it has brought great returns to numerous investors, we believe you should invest in it.
Without saying much, let’s look at private equity, coupled with some critical questions related to it.
What is private equity?
Private equity involves buying companies and managing them for some time before selling them. Simple right? As an institution or accredited investor, a private equity firm will handle the investment funds on your behalf.
The private equity funds managers will then use the funds to purchase both public and private companies and/or use them as parts of a consortium to invest in buyouts.
They don’t deal with the stock exchange, so they are never involved in companies that operate that. Private equity, venture capital, and hedge funds are considered alternative investments. Access to this investment is minimal; it requires you to pledge money for many years, so you will see that only institutions and people with high net worth can invest in it.
How does private equity work?
Private equity firms, also called PE firms, generate their money from institutions and accredited investors; they will then use the money to invest in personal business, grow the company and later sell it to generate returns and profit for their investors.
Characteristics of private equity
From fund perspectives
People might refer to private equity investments as a leveraged buyout industry. This is because the firm sometimes is funded with debt-leveraging transactions. With this practice, they can finance small amounts and maximize the benefits when sold at a gain. However, this practice also has its risks. If the reverse happens, the risks might be significant.
2. Value add operations
Once a private equity firm purchases a company, its goal is to sell it and generate profit, which will surely add value to it. Most modern firms already have value-adding teams within the company; they perform initiatives such as reorganization, cost reduction, and technological improvement. They will plan all these activities before initiating the transaction.
3. High-risk/high reward
When private equity invests in the private market, it means they are funding untested companies, which, unlike public companies, last strict reports. So the firms will reduce the risk by performing thorough research and data examination of what the potential companies offer to them.
From a company perspective
- Alternative funding access
When a firm is looking for capital, they often choose to go for loans at high interest and pay it back at the scheduled time.
- Less scrutiny
Most innovative firms work with operative growth strategies, which can hardly be approved, especially by wary investors. However, private equity firms tend to accept the risk associated with new plans.
Additionally, public companies must follow tight regulations, which are usually absent in private companies. So accessing money via private equity has more growth strategies.
- Longer strategic horizons
For general partners, investing in these portfolio companies aims to maximize the value over the years instead of earning profits instantly, which is similar to public investors.
For private equity, the average holding period is mostly 2-3 years and sometimes up to 10 years, depending on whether the firm wants to reinvest. So companies looking for long-term gain will pursue this prospect since it has value creation plans.
From an investor perspective
- Risk return profile
Compared to other investment entities, private equity provides high returns. And when you include it in your portfolio, it can affect your risk-return profile.
- Fees and carry
The funds invested in private equity firms are managed actively.
Compared to public equity, private equity is less liquid. You can only liquidate the private equity funds at the scheduled time, usually ten years.
- High minimums
Before, private equity was highly limited to a specific number of people. But now, it’s accessible to individuals despite minimal access.
- Delayed cash flow
Private equity investors pledge their capital at the fund’s opening. However, you shouldn’t expect the funds to return until toward the end of the fund’s life.
Private equity market size
- Historic growth
Before, the public market overshadowed private equity. But in recent years, developed countries are shifting towards this steady growth. People are also investing more in the private equity market than in public markets.
- Current growth
As of 2021, the private equity market has surpassed over $4.74 billion globally.
- Future growth forecast
By 2025, the private equity market will reach over $5.8 trillion in assets under management.
Private equity secondary market
Since the private equity market is characterized by delayed cash flow and illiquid nature, it has decreased your control level on your portfolio.
You can check the secondary market if you are looking for an alternative to rebalance your portfolio or want urgent liquidity. This sector permits you to liquidate your funds before the stipulated time.
Trading with the private equity secondary markets changes the cash flow profile, offers urgent liquidity, and allows reducing the risk associated with private equity. These reasons make the secondary market receive positive gazes from investors since it’s more like an alternative to the general market.
Who can invest in private equity?
Private equity still needs to be improved despite opening its doors to individuals because they have minimum contribution requirements. For example, some private equity firms allow you to invest at least $250,000, while others reach millions or even billions.
Most private equity deals funds are usually accessible to accredited investors and institutions.
One of the people who can access private equity is institutions. These include pension funds, endowment funds, and sovereign wealth.
- Accredited investors/family offices
An accredited investor is someone whose net worth exceeds $1 million. Family offices mainly control these people’s wealth.
- Small players
Despite the total funding requirements of private equity, some people can still afford the investment. These individuals cover some parts of the total managing assets of private equity. For decades these families or individuals have gained access to private equity investments through traditional methods.
3 Main types of private equity investment strategies
There are three types of private equity strategies, and each stands on its own without competing with the others and requires skills. These are venture capital, growth equity, and buyouts.
- Venture capital
If you are a startup or early-stage investor, you should consider venture capital. You will provide a company with funding in exchange for a share. You don’t need a significant percentage. The downside of this investment banking is that it is high-risk since it primarily deals with startups.
- Growth equity
Growth equity involves investing in a growing company. The investment is made chiefly for companies that are already established but are looking for additional funding to continue growing.
Private equity buyouts happen when a private equity firm acquires a matured company or management team. When a private equity firm purchases a company, the existing investors and management will remain there, except the firm will be the sole owner of the company and must hold more than 50% shares of the company.
Why Private Equity: 5 Reasons why you should invest in private equity
There are many reasons you should invest in private equity, and below are a few:
- Great gains
For the last few decades, private equity has remained one of the successful investment strategies and is still growing. One main reason people invest more in it is the potential return increase. For example, imagine the gains you would get if you could purchase Apple or Microsoft before they went public.
- Downside risk protection
One of the significant benefits of investing in private equity that is often overlooked is downside risk protection. When you add private equity investments to your portfolio, especially one that has publicly traded assets, it will help improve risk management.
- Stock market doesn’t affect private equity
While the economy can affect stock market investments, it doesn’t have any slight effect on the private equity market. Instead, the success of a private equity investment is linked to the company’s performance and metrics.
- Access to entrepreneurs
For a business to thrive, it requires good management and a strong track record. Many companies will only exist with entrepreneurs extending their hands into several industries.
Investing in private equity will allow you to access entrepreneurs and even invest in their vision. You will earn high investment returns if you perform every task wisely.
- Can influence a company’s decision
Another important reason to invest in private equity is that you can influence the company’s decision. While public trade stock investors have no say regarding a company’s inner dealings, private equity can speak regarding a decision made by the company. This will also permit you to protect your investment and improve your capital growth.
How to invest in private equity?
Below are four steps to investing in a private equity firm:
- Understand the alternative investment language
Before venturing into the private equity industry, ensure you learn and are familiar with the alternative investment language. Have a comprehensive understanding of the industry.
- Become an accredited investor
After understanding the alternative investment language, your next step is becoming an accredited investor. To be an accredited investor, you must at least be earning more than $200,000 monthly for the last two years.
Or if you have a net worth of $1 million and above. Once you are sure that you’ve met this requirement and chosen a firm to invest in, prepare to share your statement with the firm.
- Choose a private equity firm
Once you are sure you have met all the criteria for becoming a private equity investor, your following action is to research and choose a private equity firm.
Make sure you prefer a firm you trust; you can select based on your experience or private equity industry trends. While researching, ensure you are familiar with the firm’s minimum investment requirements.
- Track the industry progress
Once you are done selecting a firm, you should move ahead and invest, then sit down and be tracking the industry’s success.
Even though the management will be in the hands of the private equity managers and you will only access your money after many years, you can still monitor the progress and see how the investment is performing.
Top private equity firms to invest in
|Firm Name||Headquarters||Five-year fundraising total ($m)*|
|Goldman Sachs Principal Investment Are||New York||$489,993|
|The Carlyle Group||Washington DC||$47,732|
|Kohlberg Kravis Roberts||New York||$40,460|
|Apollo Global Management||New York||$35,183|
Difference between private equity and public equity
The significant difference between private and public equity is held in a Private company. In contrast, public equity, even from the name, involves holding shares listed on the public stock exchange.
Furthermore, private equity is accessible to institutions and high-net-worth people, while public equity is available to everybody.
Difference between private equity and public equity
|Basis for Comparison||Private Equity||Public Equity|
|Privacy of Information||Investors in private equity are not obligated to share any financial information about their stocks publicly||Investors in public equity are obligated to share the financial information on how their stocks publicly|
|Regulation||They are easy to regulate as they are privately controlled. They are not answerable to the general public or the government||It’s usually tougher to regulate because they are answerable to the general public or the government|
|Pressure||Works for a more extended period because there is no pressure from the public to confirm the returns on their investment||They don’t have much time to work because there is pressure from the public to confirm the returns on their investment.|
|Target||Target is on individuals or organizations who have many capital reserves to invest due to the requirements of the investment||Target is usually towards the general public due to the requirements of the investment|
|Trading Assets||Assets can only be traded among the investors and the public with the approval of the founder||Assets can be traded among investors and the public freely. They don’t need any approval from the founder|
Now that private equity has opened its doors for more investors, you have many reasons to invest in this strategy. Aside from earning significant gains, private equity will allow you access to great entrepreneurs, you will have the chance to influence a company’s decision, it offers downside risk protection, and it’s never affected by the stock market.
If you like to start investing in private equity firms, it’s also relatively easy. The requirements are just for you to understand the alternative investment language, be an institution or accredited investor, search for the best firm you want to invest in, and you are good to go.