A Beginner’s Guide to Private Equity Investing

The amount of individuals looking to get involved with investments has skyrocketed this past year as the U.S government and Federal Reserve have instilled confidence in the markets. According to research from the PEW Research Center, over half of American households have some money invested in the stock market.

Private equity investing, however, is a different story. Up until recently, private equity investing has been chiefly reserved for those who can afford it with high entry barriers.

If you are interested in investing in private equity, keep reading this investing guide to learn more about the excellent business opportunity and how to get started today.

What is Private Equity Investing?

Instead of investing in public companies such as Apple or Tesla, investors will sometimes invest in companies that are not publicly listed. Just as you would when investing in public companies, you trade funding for a part ownership stake in the company.

These businesses are often newer companies and can be considered riskier as they have yet to establish themselves in their respective markets. Although investors can take on more risk when investing in private equity, the reward is also higher, giving them the potential to generate higher returns on their investment.

According to a pension study from the American Investment Council, private equity has been outperforming public markets in public pension fund returns. The study noted that private equity investments managed an average return of 10.2 percent. In comparison, public equity only generated 8.5 percent in returns during the same period.

Private equity investing has been reserved for wealthy individuals throughout history that can afford to contribute a significant amount of money. This often amounts to millions or at least hundreds of thousands of dollars.

However, this trend has shifted lately as new private equity opportunities have emerged. The result is new ways of investing in businesses for individuals that don’t necessarily have millions to contribute.

Advantages and Disadvantages

Investing in private equity can prove to be an outstanding way to generate returns. Keep in mind though it does have certain disadvantages to be aware of.

Advantages

One of the most significant advantages of investing in private equity is its ability to grow relatively quickly. Often private equity will go towards smaller companies that have the ability to jumpstart operations.

Private equity investors also receive the benefit of being a part of a company at the ground level. Getting in at the ground level gives investors the potential to experience the company grow into something extraordinary.

Investing in private companies gives you the ability to diversify your holdings and protect your account from market downturns.

Disadvantages

When you invest in private equity, you will have to treat it as a long-term investment opportunity in most instances. It’s not always easy to liquidate your position. Investments in private equity can take years for the initial investment to generate a return, unlike when selling an asset such as stock, where you can initiate the trade. It is executed the same day, sometimes within seconds.

There is also the chance the company doesn’t expand its operations and fails to generate a profit. Since most of these businesses are relatively new, certain risks come along with them, such as:

  • Not being able to gain market share
  • Failed product launch
  • Running out of cash

These are just a few things to keep in mind with private equity investments, as the company’s information can be limited.

How to Get Started Investing in Private Equity

There are several ways you can go about investing in businesses in the private equity realm. These include the following:

Private Equity Fund of Funds

Investing in a fund of funds (FOF) is a common type of private equity investing where participants will contribute money to a combined “pool of funds.” The fund manager will then invest the pooled resources into various private equities.

Through the fund of funds, investors can gain exposure to a more diverse portfolio, giving them additional peace of mind knowing their money isn’t tied up in one company. Although investing in a FOF can be less risky, it typically costs more to invest this way through fees and other expenses.

Additionally, private equity fund of funds can sometimes be challenging to participate in as they are often reserved for individuals with a high net worth.

Crowdfunding

A relatively new concept, private equity crowdfunding offers a chance for investors who don’t necessarily have a high net worth to invest in private businesses. There are several websites and other resources that provide the ability to retail investors.

With crowdfunding, the minimum requirements are generally lower than what you would experience with a fund of funds.

Special Purpose Acquisition Company (SPAC)

SPAC’s are not a brand new concept, although they have exploded in popularity in the past year. They are considered a “blank check company” or a “shell company” where the entity is created to raise money through an IPO. The capital is then used to obtain a private business.

This gives investors the ability to invest in public companies through the use of a publicly-traded entity.

Exchange-Traded Fund (ETF)

ETFs are common public investment vehicles designed to give investors access to a host of different securities. With private equity ETF’s, the fund is designed to invest in private companies to give shareholders access to private equity.

Looking for Your Next Business Opportunity?

Investing in private equity can give you the ability to get in on the ground floor of an extraordinary company with the ability to generate significant returns. However, it’s essential to keep in mind the risks involved with these companies. The risks can include illiquidity, scalability, and competition risk. If you are considering this business opportunity, you have several options available that can help you get started investing in non-public companies, such as crowdfunding or investing in a special purpose acquisition company (SPAC).

If you’d like to discover more investing advice and other helpful personal finance topics, check out the rest of our blog!

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