In 2019, private equity firms held at least $3.9 trillion in assets, an increase of 12.2% from the previous year. But what is Private Equity?
What is Private Equity?
Private equity is an investment in an interest of an entity that is not publicly traded or listed. Its investment capital comes from firms and high-net-worth investors that purchase stakes in private companies. Private equity is done to gain leverage and control of public companies and eventually take them private and delist thee companies from the stock exchanges.
Due to the nature of the private equity industry, it mostly comprises of pension funds, institutional investors, and private equity firms that are funded and backed by accredited investors. Because private equity requires direct investments to acquire control or influence on a company’s operation, it entails a large capital outlay.
Deep-pocketed funds dominate the private equity industry, often requiring accredited investors a minimum capital. The required capital can range from $250,000 to over a million dollars.
The pursuit of investors in private equity is often motivated by the pursuit of a positive return on investment with an investment horizon before a ten-year mark.
How Do You Invest in Private Equity Funds?
Private equity entails a significant capital investment that allows private companies to develop new technologies and products, make acquisitions, or strengthen a company’s balance. As a high-risk investment, there are a few ways you can invest in private equity funds.
Funds of Funds
These hold shares of private partnerships that invest capital into individual equities. It provides an increase in cost-effectiveness while minimizing investment requirements. Funds of Funds also have greater diversification as they invest in multiple companies representing different phases of venture capital.
Because of the size and nature of funds of funds, it potentially lowers risks than other private equity investments.
Private Equity ETF
You can also purchase shares from a private equity exchange-traded fund (ETF) that tracks and indexes publicly traded companies. Because you invest in individual shares in stock exchanges, you don’t have to worry about any minimum investment requirements. However, it entails an additional layer of management expenses that are often not encountered in direct private equity investments. Additionally, depending on your brokerage, there may be fees every time you buy or sell shares.
Special Purpose Acquisition Companies
You can also invest in publicly-traded shell companies or companies that have no active operation or have yet to produce significant assets. These companies make high-risk investments in undervalued private companies.
Since Special Purpose Acquisition Companies often invest in one company offering no diversification, it has a higher risk than other investment options.
Advantages of Private Equity Fund Investment
For investors with sizeable assets, private equity fund investment offers a plethora of advantages and benefits.
Private equity funds offer considerable long-term growth potential. Since most of these investments range from seven to ten years, the returns in the private market significantly outperform the public market.
Private equity funds invest in multiple entities generating fewer risks for your investment. Still, the factors that often drive the public equity market have little to no effect on private equity.
Because of the duration, a private equity investment holds on a company; this allows private equity firms to bring in their expertise and management to better an existing company. This increases your investment return, but it also allows a more extended strategic focus on the company.
Disadvantages of Private Equity Fund Investment
Nothing is perfect, especially in the high-risk market of private equity funds. There are some advantages and key points that should be considered before getting started on your investment.
Most investments range from a three-year to a ten-year investment period. Unless you are fully committed to tying your capital for long-term investment and patiently waiting for the return of investment, private equity funds may not be for you.
Blind Pool Investing
Committing to a private equity fund equates to providing capital to fund by the General Partner. As an investor, however, you have the right to provide a broad discretion on companies you want to have a share in.
Private equity is a high-risk investment, not for the faint of heart. Direct investments entail minimum capital requirements, but they also tie you to a stake for several years to a decade. Despite its lucrativeness, many find it difficult to pass the minimum requirements for direct investments.
On the other hand, private equity funds, depending on what fund you’re investing in, can lower the risks and minimum capital requirement. As good as it sounds, there are significant risks that should be taken into consideration.