Investing in private equity: What you need to know
Private equity is a type of investment that involves buying and owning shares in privately held companies. It’s a way for investors to participate in the growth of a company that is not publicly traded, and it has the potential for significant returns. However, it’s important to understand the risks and benefits of private equity before deciding whether to invest.
What is private equity?
Private equity firms generally focus their investments on privately held companies, which they acquire either by obtaining a controlling interest or through outright acquisition. To enhance operational efficiency and facilitate growth, private firms collaborate closely with the management of the company.
This type of collaboration often involves sharing expertise, providing strategic guidance, and offering valuable industry connections. In addition, these firms may also provide financial support and access to additional capital to fuel the company’s growth trajectory. Ultimately, such collaborations can result in significant improvements in the company’s performance and market position.
Large institutional investors such as pension funds, endowments, and wealthy individuals typically make private equity investments. These investors seek higher returns than they can achieve through traditional investments such as stocks and bonds.
Benefits of private equity investing
Higher returns:
Private equity investments have historically provided higher returns than traditional investments. According to data from Cambridge Associates, the average annual return for private equity investments was 16.1% over a 10-year period ending in 2020, compared to 7.5% for the S&P 500 index. Of course, these returns can vary widely depending on the specific investments and the performance of the underlying companies.
One reason private equity can provide higher returns is that it allows investors to invest in companies that are not yet publicly traded. These companies may have significant growth potential that has not yet been fully realized, and private equity firms can help to unlock this potential by providing capital and strategic guidance.
Diversification:
Private equity investments can help to diversify your investment portfolio, which can help to reduce overall risk. This is because private equity is not correlated with the stock market, meaning that the performance of private equity investments is not tied to the performance of publicly traded stocks. This can provide a hedge against market volatility and provide a more stable return stream.
In addition, private equity investments can provide exposure to different sectors of the economy that are not available through public markets. This can help investors to diversify their portfolio and reduce their exposure to any single industry or sector.
Control:
Private equity investors have some control over the companies they invest in. This is because private equity firms typically take a significant stake in the companies they invest in and may even take a seat on the board of directors. This allows investors to provide input on important decisions and help to steer the company towards success.
Risks of private equity investing
While there are benefits to investing in private equity, there are also risks:
Illiquidity:
Private equity investments are not easily bought or sold. They are typically held for several years before they can be sold, which means investors may not have access to their money for a long period of time.
Limited information:
Private companies are not required to disclose as much information as publicly traded companies. This means that investors may not have as much information about the company they are investing in as they would if they were investing in a public company.
High risk:
Private equity investments are generally considered high-risk investments. Investing in a private company can be risky, as there is no guarantee that the company will be successful.
How to invest in private equity
Investing in private equity is typically only available to institutional investors and wealthy individuals. However, there are ways for individual investors to invest in private equity:
Private Equity Funds: Private equity funds pool money from multiple investors and invest that money in private companies. Investors in these funds receive shares in the fund, representing their ownership in the company the fund invests in.
Direct Investments: Some private equity firms allow individual investors to invest directly in their portfolio companies. However, these investments typically require a large minimum investment.
Secondary Market: The secondary market allows investors to buy and sell shares in private equity funds. This allows investors to access the private equity market without directly investing in a company.
Conclusion
Private equity can be lucrative for those willing to take on the risks. Understanding the benefits and risks of private equity before investing is important. If you are interested in investing in private equity, consider working with a financial advisor who can help determine if it’s the right investment.
