When it comes to investment, one of the first key tips you’re likely to receive is the importance of diversification. Usually, there’s a sweet spot of 20-30 different types of stocks spread out over various industries, with other assets like bonds, real estate, and CDs on top of that. Private equity investing can be an excellent way to diversify your portfolio and access opportunities not available in public markets. However, it can also be more complex and risky than traditional investments. In this article, we’ll break down what private equity is and how you can get started with it.
What Is Private Equity?
Private equity refers to investments made directly in private companies, or in the buyout of public companies, to take them private. These investments typically involve purchasing shares in a company that is not listed on a public stock exchange. Private equity investors aim to increase the value of these companies over time and eventually sell them for a profit.
Types Of Private Equity Investments
One of the primary types of private equity investments is venture capital. Venture capital focuses on investing in early-stage companies that have high growth potential but are usually more speculative and risky. Another type, growth equity, targets more established companies that need capital to expand or restructure their operations. It carries less risk than venture capital but still offers significant growth potential.
When learning how to invest in private equity, you’ll not go long before you start to hear about buyouts. In buyout deals, private equity firms acquire controlling stakes in mature companies, often using a combination of equity and debt. These deals aim to improve the company’s performance before selling it for a profit.
Finally, there’s distressed investing. Distressed investing involves purchasing companies that are struggling financially, with the goal of turning them around and profiting from their recovery – literally grabbing on when they’re ‘in distress.’
How To Invest In Private Equity
Become Accredited
Before you begin your private equity journey, you’ll need to set yourself up with accredited investor status. It may be a tricky, time-consuming process, but it’s entirely necessary. Most private equity investments are only open to accredited investors – and this isn’t just a matter of preference. Federal securities law actually restricts most private-market investment investments to only two types of investors. One of those is the accredited investor, a title reserved for those who meet certain annual income thresholds.
To qualify as an individual, rather than a business, you typically need a high net worth or a significant income threshold, often $1 million in net worth or $200,000 in annual income. This can also extend to financial professionals who are in good standings and are in possession of a securities representative license (Series 7) obtained by passing an exam, an investment adviser representative license (Series 65) also obtained through a 130 question exam, or a private securities offerings representative license (Series 82) which is required for the solicitation or sale of private placement securities.
Begin Investing
Once you’re qualified, you can invest directly in a private company by purchasing shares. However, this option requires a large capital outlay and deep industry knowledge.
The most common way to access private equity is through private equity funds managed by professional investment firms. These funds pool money from multiple investors to invest in a portfolio of companies, reducing individual risk.
Funds Of Funds In Private Equity
Since learning how to invest in private equity is one way of attaining diversification, learning about the fund of funds (FoF) method is one way to facilitate both. A FoF allows investors to diversify across multiple private equity funds, offering broader exposure to various companies and sectors. However, this option may come with higher fees. In 2023, the global fund of fund market was roughly estimated to be worth about $6.8 billion.
The Secondaries Market And Publicly Traded Options
The private equity secondaries market is another type of transaction one might encounter in private equity investing. The secondaries market allows investors to buy shares of private equity investments from existing shareholders. This can be a way to access private equity without waiting for new fundraising rounds. Secondaries are on the rise in the private equity market, since they’re flexible and somewhat ‘safer’ for investors looking to liquidate a portfolio. There’s a faster ROI with secondary markets, as secondary funds diminish that dreaded J-curve that one usually finds in a private market portfolio.
For those unable to invest directly in private equity, some publicly traded investment vehicles, like business development companies (BDCs) or private equity ETFs, offer indirect exposure. These are referred to a publicly traded options.
Risks Of Private Equity Investing
Private equity investments can offer significant returns, but they also come with notable risks. The chief among these include illiquidity. Unlike stocks, private equity investments are not easily bought or sold. You may need to commit your capital for several years before seeing a return.
Those who are experienced in private equity will have much to say about the high fees, and as you learn how to invest in private equity, fees should be expected. Private equity funds often charge high management and performance fees, which can eat into returns.
Another con is limited transparency. Private companies are not required to disclose as much financial information as public companies, making it harder to assess their performance.
As with any investment technique, it’s best to always prepare for market volatility. Economic downturns can severely impact private companies, especially those in the early stages or those heavily leveraged through buyouts.
Learning How To Invest In Private Equity Can Be Extremely Lucrative
Private equity offers opportunities for high returns, but it also carries risks and requires significant capital. For investors who meet the qualifications and are willing to take on the challenges, private equity can be a valuable addition to a diversified investment portfolio. By understanding the different types of private equity investments and the methods to invest, you can make informed decisions that align with your financial goals.
