Guide to Investing in Private Equity

Private equity involves investing in companies that are not publicly traded, with the goal of increasing their value through operational improvements, strategic changes, and, ultimately, selling them for a profit. Private equity investments are typically medium to long-term, with investors often holding companies for several years to allow for maximum value creation.

Private equity firms typically raise capital from institutional investors like pension funds, insurance companies, endowments, and high-net-worth individuals. Private equity investments can take a variety of forms, including leveraged buyouts (buying established companies with debt), growth equity (investing in fast-growing companies), and venture capital (investing in early-stage startups).

Private equity investments are typically illiquid, meaning they cannot be easily bought or sold, and they carry a higher level of risk compared to public equity investments. Here’s what investors need to know about how to invest in private equity.

Who can invest?

Who can invest in private equity?

Due to securities law restrictions and high investment minimums, private equity investments are typically open to accredited investors and qualified clients. As a result, investors are often institutional investors or individuals with significant net worth. The accredited investor designation allows individuals and entities to participate in investments that are not registered with the Securities and Exchange Commission (SEC).

These investments, such as private equity funds, often have higher potential returns but also come with greater risks and less regulatory oversight compared to publicly traded securities. To qualify as an accredited investor as an individual, a person must meet numerous requirements including:

• Having a net worth of more than $1 million (excluding the investor’s primary residence).
• Have a minimum annual income of $200,000 (or $300,000 jointly with a spouse) for the last two years, with an expectation of continuing to meet that income level.

Corporations, partnerships, limited liability corporations (LLCs), trusts, or other entities with assets exceeding $5 million, family offices that meet specific criteria, and entities where all equity owners are accredited investors may also be considered accredited investors. Some private equity funds may require a higher level of qualification, such as having a certain amount of investable assets.

Given all of these factors, private equity investors are usually institutional investors. These include large entities like pension funds, insurance companies, university endowments, and sovereign wealth funds. Private equity funds often have high minimum investment requirements, ranging from a few hundred thousand to several million dollars.

Types of investments

Types of private equity investments

There are numerous types of private equity investments. These forms of private equity investing are broadly categorized by the stage of the company and the underlying investment strategy.

• Venture capital investing: Involves providing funding, typically in exchange for equity, to early-stage, innovative businesses with high growth potential with the goal of achieving significant returns if the company succeeds. This route typically follows a series of rounds, starting with pre-seed, seed, Series A, B, C, and beyond, each representing a different stage of company growth and risk tolerance.
• Growth equity investing: Unlike venture capital, which invests in early-stage startups, growth equity targets companies that have already demonstrated success and are poised for rapid growth. This can allow the existing management team to retain control and operational autonomy. The capital provided by growth equity firms is used to support a company’s expansion plans, such as entering new markets, developing new products, or scaling operations.
• Leveraged buyouts: A leveraged buyout (LBO) is an acquisition of a company where a significant portion of the purchase price is financed by debt, with the acquired company’s assets often used as collateral. A buyer (often a private equity firm) borrows a large amount of money to purchase a company, using the acquired company’s assets and future cash flows as collateral for the loans. The private equity investor aims to use the company’s cash flow to repay the debt and potentially generate profits.
• Distressed investing: Investing in companies that are experiencing financial difficulties or are on the brink of bankruptcy. Private equity firms specializing in distressed investing aim to capitalize on situations where companies are undervalued due to their financial struggles. The ultimate goal is to restructure the company, improve its performance, and eventually exit the investment through a sale or initial public offering (IPO).

How to invest

How to invest in private equity

Private equity investments typically require substantial capital outlays, often exceeding what’s required for public market investments. Private equity investments are typically long term, with a holding period of several years, often five to 10 years or more.

1. Direct investments

In private equity, investors can either invest directly in a company or indirectly. Direct investments involve an investor directly purchasing equity or debt in a private company, while indirect investments involve investing in a fund that then invests in private companies. Large institutional investors, individuals with substantial wealth, or family offices (which manage the wealth of wealthy families) often make direct investments in private equity.

2. Private equity funds

Investing in private equity funds means investing in a pool of capital managed by a firm that specializes in acquiring and growing privately held companies, aiming for long-term value creation and potential high returns. Minimum investment amounts for private equity funds can be high, ranging from $250,000 to $25 million or more. Both institutional investors and high-net-worth individual investors can invest in private equity funds.

3. Funds of funds (FoFs)

Private equity funds of funds are another type of private equity investment. This type of investing works by pooling capital from multiple investors and investing it in a portfolio of other private equity funds rather than directly in individual companies, providing diversified exposure to various strategies and managers.

4. Private equity exchange-traded funds (ETFs)

Private equity exchange-traded funds (ETFs) provide a way for retail investors to gain exposure to the private equity market without needing to meet the high investment thresholds or deal with the complexities of direct private equity investments. These ETFs track the performance of publicly traded companies that invest in private equity, effectively giving investors indirect exposure to the private equity asset class. Traditional private equity investments are typically illiquid and require large minimum investments, while private equity ETFs offer a more liquid and accessible way to gain exposure to this asset class.

5. Private equity crowdfunding

Private equity crowdfunding allows individuals to invest small amounts to become partial owners of companies, making it more accessible than traditional private equity investments, which often require high minimum investment thresholds. Companies raising money through equity crowdfunding must follow specific SEC regulations. Equity crowdfunding can attract a broad range of investors, including individuals, family, friends, and business partners who are interested in supporting a company’s success.

While anyone can invest, the rules limit the amount that non-accredited investors can invest in crowdfunding offerings during any 12-month period. Equity crowdfunding is typically facilitated through online platforms, allowing entrepreneurs to connect directly with a community to fund their ideas.

Risks and benefits

Risks and benefits of private equity investing

There are numerous risks and benefits of private equity investing to consider, depending on the type of investor you are. For individuals who have the substantial capital necessary to invest in private equity, benefits can include:

• Private equity investments have historically shown the potential to outperform public markets.
• Private equity investments are less correlated to public markets, offering diversification benefits and helping to mitigate portfolio risk.
• Private equity individuals and institutional investors often invest in companies that are not publicly traded, providing access to investment opportunities not available in the public markets.
• Private equity can act as an inflation hedge since the value of the underlying assets may increase during inflationary periods.
• Private equity investments are typically long-term investments, which can be attractive for high-net-worth individuals seeking to build wealth over time.
• Private equity investments can offer tax advantages, such as the ability to defer capital gains taxes.

However, there are some drawbacks to consider as well:

• Private equity funds often have high minimum investment requirements, ranging from a few hundred thousand to several million dollars.
• To invest in private equity, you usually need to be an accredited investor or qualified client, meaning you meet certain financial thresholds.
• Private equity investments are illiquid, meaning investors’ funds are locked in for a certain period (often five to 10 years) and cannot be easily accessed.
• Private companies are not required to disclose financial information as frequently as publicly traded companies, making it harder to assess the true value of an investment.
• Private equity investments can involve significant risks, including the potential loss of your entire investment.
• Private equity funds often use a significant amount of debt to finance their investments, which can amplify both potential gains and losses.

These factors also tend to keep most individual investors, apart from those with a substantial net worth, from investing in private equity apart from routes like private equity ETFs or crowdfunding.

Related investing topics

Should I invest?

Is private equity investing for me?

Private equity investments are primarily for institutional investors, such as pension funds and endowments, and high-net-worth individuals who can meet the high minimum investment requirements and are accredited investors. Private equity is a complex investment area, so investors should have the knowledge and experience to understand the risks and opportunities involved.

Carefully assess the risks associated with private equity investments and ensure you are comfortable with them. Seek advice from financial advisors or other professionals who specialize in private equity investments.

Private equity investments are risky, so only invest the amount of money you are willing to lose, and don’t put all your eggs in one basket. Always diversify your investments to reduce overall risk.

FAQ