If you’re looking for a lucrative investment opportunity that will diversify your portfolio, check out private equity. It’s a four trillion dollar industry that offers the potential for returns far exceeding those in traditional public markets. Investing in private equity provides capital for businesses to grow, innovate, and succeed over the long term.
What Is Private Equity?
Private equity refers to investments made in companies not publicly traded on stock exchanges. If you make this type of investment, you hope that a private company will increase in value over time so you can sell your shares for a profit. Private equity firms, venture capitalists, and accredited investors often invest in private equity.
Although private equity investments look different today, the concept started long ago — from the early 20th century, to be exact. The most famous historical instance of private equity happened in 1901 when railroad companies struggled for funding and turned to private banks for assistance. By offering their funds, notorious banks like JP Morgan & Company then had a controlling interest in reconfiguring railroad companies like Carnegie Steel into one of the most famous companies that still exist today.
Since then, private equity firms have risen to prominence as a way to acquire companies, restructure them, and improve their profitability. Private equity firms now manage trillions of dollars in assets globally— $8.2 trillion. Although this growth rises and falls yearly with current economic conditions, many see private equity as a way to stimulate the economy.
Private Equity vs Public Equity
Public equity, on the other hand, is more common. This concept is simple — investing in publicly traded companies. Public equity is more available than private equity since it is sold on public market exchanges, and you can easily trade it for liquid funds. Private equity also takes various forms, such as an IRA, a mutual fund, and a 401(k).
That said, most funds received from public equity come from stock accumulation, while private equity funds come from distribution. Also, private equity investments don’t provide ownership privileges like private equity can provide.
Private Equity vs. Investment Banking
Both private equity and investment banking are different ways organizations can obtain private equity, either through private equity firms or investment banks. Private equity firms invest their funds into private equity with the hope of building their income if the value of the business rises. From here, private equity firms will sell their interests in a company as an initial public offering. Conversely, investment banks operate with the sole intention of offering services to help businesses successfully merge and acquire businesses. They also advise businesses on what equity to invest in — whether private or public.
The critical difference between the two is their long-term and short-term solutions. Investment banks earn income through short-term solutions, while private equity firms earn income by investing in and selling private equity long-term.
Private equity investments are long-term and high-risk, aiming for substantial returns, whereas investment banking deals are shorter-term and transaction-based, generating revenue through fees. Understanding these differences helps individuals and businesses determine which financial services best suit their needs, whether they seek capital, wish to sell a business, or aim to invest in private enterprises.
Benefits of Investing in Private Equity
There are various reasons to invest in private equity as a business, including:
- Potential for high returns: Private equity investments often have the potential to generate substantial returns, as private equity firms and portfolio companies work together to enhance the value of the company through strategic management and operational improvements.
- Access to exclusive investment opportunities: Private equity isn’t as readily available as public equity. Because of this, you’ll be able to chip into high-growth private companies and receive significant financial gains if those companies decide to participate in a buyout.
- Portfolio diversification: Including private equity in an investment portfolio can offer diversification benefits. The more diverse your portfolio is, the less risk you have if one investment performs poorly due to market downturns.
- Stability: Unlike public equity, which is often more susceptible to short-term volatility, private equity investments often grow in value over a more extended period, providing significant returns.
Because of these benefits, many businesses turn to private equity firms and investment banks to help them get started with their financial future.
Risks of Investing in Private Equity
Just as there are plenty of benefits to investing in private equity, there are an equal amount of risks, including:
- Illiquidity and long lock-up periods: Private equity investments are typically illiquid, meaning you can’t easily sell or trade them as public equity assets. If you want to invest in private equity, you’ll often have to sign a contract with a lockup period that probits the sale of your assets, so you won’t be able to access any capital you’ve invested or earned from the company.
- High minimum investment requirements: Private equity funds usually require high minimum investments, often making them accessible only to institutional investors and high-net-worth individuals.
- Complexity and lack of transparency: Private equity investments are often complex, involving intricate financial structures and strategies. Additionally, the federal government has less regulatory oversight over private equity, allowing companies to get away with providing little disclosure to investors. This then leads investors to make inadvisable investments based on the risk and performance of the private equity asset.
- Potential for capital loss: Like any investment, private equity risks capital loss. The success of private equity investments depends heavily on the firm’s ability to improve the performance of its portfolio companies.
With this level of risk and commitment, you must consider private equity investments carefully.
Private Equity Investment Strategies
Private equity has the potential to boost your company significantly. That is, it can, as long as you invest with strategy in mind. Often, this strategy involves investing in a specific type of asset or when you’d like to invest in that asset. Here are the most common:
Venture Capital
With a venture capital (VC) investment, you’ll typically invest in a startup or a young business with high growth potential. By investing in this type of company, you’ll help scale its operations so it can develop more products and expand to new markets, eventually growing its revenue as a result.
You can invest in venture capital at several key growth stages of a company, including:
- Pre-seed stage: This is the earliest phase in which investors provide initial funding. The business may already have an idea, but it needs funding to conduct market research and build its product.
- Seed stage: At this point, the business has built its idea into an actual product but will need help from investors to market it and grow operations.
- Early Stage: At this stage, companies have a developed product and some market traction. Early-stage funding helps businesses scale operations, hire key personnel, and expand their customer base.
By investing in venture capital, you can provide strategic guidance to a new company, giving you more control of the company’s success. The flip side of this benefit is that the business may fight against high expectations — if they don’t meet them, they could fail, leading to a significant loss. In addition, you may lose more control and capital if the company seeks more investors who will also seek influence over the company.
Buyouts
Buyouts are another private equity investment strategy in which a firm acquires a controlling interest in a company. These buyouts can involve various approaches, including:
- Leveraged Buyouts (LBOs): A significant portion of the purchase price is financed through borrowed funds, using the company’s assets as collateral. This allows private equity firms to acquire companies with relatively little capital investment. The goal is to improve the company’s value through strategic management and sell it at a profit.
- Management Buyouts (MBOs): An MBO occurs when a company’s existing management team purchases the company, often with private equity financing. This type of buyout aligns the management team’s interests with those of the investors, as the managers have a personal stake in the company’s success.
Like other private equity strategies, buyouts can give companies the finances to grow, providing significant returns for investors and company leaders. However, buyouts also come with risks and drawbacks. The high debt levels involved in LBOs can place significant financial strain on the acquired company, potentially leading to insolvency if the company fails to generate sufficient cash flow. Additionally, focusing on cost-cutting measures can sometimes negatively impact the company’s operations and employee morale.
Growth Equity
Growth equity, or growth capital, is a private equity investment aimed at mature companies seeking capital to change or grow their operations. Unlike venture capital, which focuses on early-stage startups, growth equity is typically invested in companies already generating revenue and have proven business models but require additional funds to accelerate their growth.
Growth equity investments are typically less risky than early-stage venture capital, as they target companies with proven business models and revenue streams. However, since these companies most likely have other investors or an established leadership board, there may be conflicts about the company’s strategic direction.
Distressed Investments
Distressed investments involve acquiring the securities of companies that are experiencing financial difficulties. These investments are often cheaper than other private equity investments, and investors often make them to restructure the company and profit from a company’s recovery. On one hand, this strategy can be financially savvy if the company does succeed — since the asset is a fraction of its original selling price, you’ll receive more returns as the company grows. However, this strategy is often more volatile since the economic market will fluctuate more as news spreads about the company’s recovery efforts.
This type of investment is also more complicated, as you’ll need to know bankruptcy laws, how to restructure companies, and how to handle everyday challenges facing a distressed company. If you do invest in the company, you won’t be able to easily pull back your funds quickly, which could lead to substantial losses.
Fund of Funds
A fund of funds (FoF) is an investment strategy where a fund manager will invest in multiple types of investment funds rather than solely investing in individual assets. Often, businesses that opt for this strategy will have to pay a management fee for a fund manager who will continue to oversee the portfolio and add additional promising investments. This is often more convenient for bigger businesses that may have limited availability.
However, this strategy can also dilute your fund performance—if one of your funds performs well but you don’t invest as much in it because you’re also funding multiple other assets, you won’t see as significant a return on investment as if you invested solely in that specific asset. Additionally, investors have limited control over the specific underlying funds and allocation decisions, and the performance of a FoF depends on the success of both the FoF managers, adding an extra layer of dependency and potential risk.
Real Estate
Private equity real estate is an investment strategy where private equity firms invest in real estate properties or real estate-related assets. These investments range from residential, commercial, and industrial properties to real estate development projects and distressed real estate assets. The primary goal is to generate returns through property appreciation, rental income, or improving and selling the properties.
Investing in real estate for private equity offers several advantages, including the potential for high returns through property appreciation and rental income, which can provide a steady cash flow. Real estate investments also hedge against inflation, as property values and rents typically rise with inflation. However, there are also drawbacks. Real estate investments are more susceptible to changes in federal interest rates and may depreciate if not cared for. The key to avoiding these downturns is to evaluate the real estate market carefully before investing and manage and maintain the properties afterward.
How To Choose a Private Equity Fund
When choosing a private equity fund, you must research the asset you’re considering investing in to make sure the asset has the potential. Here are the key steps to follow:
- Evaluating fund performance: Look for a track record of success and evidence of the fund’s ability to generate returns in different market conditions.
- Understanding fund structure and fees: Pay close attention to the fee structure, including management fees, performance fees, and any other costs associated with the fund. High fees can significantly impact your net returns, so it’s essential to understand what you will be paying and why.
- Assessing the fund manager’s experience and expertise: Look for relevant industry experience and a solid reputation in the private equity space. The success of a private equity fund often hinges on the skill and judgment of its managers.
- Reviewing fund terms and conditions: Carefully review the fund’s terms and conditions, including the investment horizon, liquidity provisions, lock-up periods, and any withdrawal restrictions or redemptions. These conditions should match up with your expectations. If not, you’ll need to negotiate before committing.
Follow these steps to avoid making an uninformed investment, resulting in significant losses.
How To Invest in Private Equity
Once you’ve picked the right fund, you should also evaluate your business’s financial situation by assessing your income, expenses, savings, and existing investments. Ideally, you should have enough revenue to support an illiquid investment.
You should also establish investment goals and how private equity can achieve these goals. Simultaneously, these goals should also include your risk tolerance, as private equity can be high-risk with the potential for substantial returns and significant losses. Reflect on your ability to withstand market volatility and financial setbacks, and align your risk tolerance with the nature of private equity investments.
Managing and Monitoring Your Private Equity Investments
Unfortunately, you can’t invest in private equity and move on with little thought. For the best outcome, you’ll need to manage and monitor it. You can regularly review financial statements, including revenue growth, profitability, and cash flow. By staying informed, you make informed and timely decisions about future financial decisions.
You should also stay engaged with the fund manager to gain their insight on the private equity fund. This way, you can ask questions, express concerns, and understand how they manage your investments.
Additionally, periodically rebalance your investment portfolio based on your earnings and financial goals. Review and adjust your portfolio regularly, as your private equity investments may provide higher returns, allowing you to add more assets to your risk tolerance. This assessment should also include predictions for market conditions, so your portfolio matches your long-term goals. The more you assess your portfolio, the more you can stay on top of the changing market.
Conclusion
Ultimately, your choice of a private equity fund depends on your goals as a business and what you can financially handle. Although we encourage you to evaluate private equity investments carefully based on how they can meet your financial goals, real estate investments can be particularly lucrative if you have the funds to support the investment. If you need help managing this investment, Viking Capital is here to help. Contact us today to see how you can get started with your private equity investment in real estate!
FAQs about Private Equity Investing
How Is Private Equity Different From Public Equity?
Public equity involves investing in companies listed on public stock exchanges, where shares can be easily bought and sold. Private equity, on the other hand, involves investing in private companies which are not publicly traded. This makes these investments less liquid. You can also hold private equity investments for more extended periods.
What Are the Typical Returns From Private Equity Investments?
Returns from private equity investments can vary widely depending on the type of investment and the performance of the underlying companies. Historically, private equity has offered higher returns than public equity, but this comes with higher risks and longer investment horizons.
Who Can Invest in Private Equity?
Private equity investments are generally available to accredited investors and institutional investors. Accredited investors meet certain income or net worth criteria set by regulatory authorities, ensuring they can bear the risks associated with private equity.
What Are the Main Types of Private Equity Investments?
The main types of private equity investments include venture capital, leveraged buyouts, management buyouts, growth equity, and distressed investments. Each type has its characteristics, risk profiles, and potential returns.
How Can I Evaluate a Private Equity Fund Before Investing?
Evaluating a private equity fund involves reviewing its performance track record, understanding its investment strategy and focus, assessing the experience and expertise of the fund managers, analyzing the fee structure, and reviewing the terms and conditions of the investment.
What Fees Are Typically Associated With Private Equity Investments?
Private equity funds usually charge management fees and performance fees. Management fees are typically 1-2% of the committed capital, while performance fees (or carried interest) are usually around 20% of the profits generated by the fund above a certain return threshold.
Can I Invest in Private Equity Through My Retirement Account?
Certain retirement accounts, such as self-directed IRAs, allow investments in private equity. However, doing so requires careful consideration of the risks and potential returns and complying with regulatory requirements.
What Is the Minimum Investment Required for Private Equity?
The minimum investment required for private equity can vary widely depending on the fund and the firm. It can range from $250,000 to several million dollars, making it more suitable for high-net-worth individuals and institutional investors.
How Do Private Equity Returns Compare to Public Market Returns?
Historically, private equity has outperformed public market returns over the long term. However, this higher potential return comes with increased risk, longer investment horizons, and less liquidity than public equities.
