Private equity is capital made available to private companies or investors. The funds raised might be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company's balance sheet.Unless you are willing to put up quite a bit of cash, your choices in investing in the high-stakes world of private equity are minimal.
Key Takeaways
- Private equity investing includes early-stage, high-risk ventures, usually in sectors such as software and healthcare.
- These investors try to add value to the companies they invest in by bringing in new management or selling off underperforming parts of the business, among other things.
- The minimum investment in private equity funds is typically $25 million, although it sometimes can be as low as $250,000.
- Investors should plan to hold their private equity investment for at least 10 years.
- Non-direct ways to invest in private equity include funds of funds, ETFs, and special purposes acquisition companies (SPACs).
Why Invest in Private Equity?
Institutional investors and wealthy individuals are often attracted to privateequity investments. This includes large university endowments, pension plans, and family offices. Their money becomesfunding for early-stage, high-risk ventures and playsa major role in the economy.
Often, the money will go into new companies believed to have significant growth possibilities in industries such astelecommunications, software, hardware, healthcare, and biotechnology. Privateequity firms try to add value to the companies they buy andmakethem even more profitable. For example, they might bring in a new management team, add complementary companies,aggressively cut costs,or spin off parts of the business that are underperforming.
Minimum Investment Requirement
Privateequity investing is not easily accessible for the average investor. Most privateequity firms typically look for investors who are willing to commit as much as $25 million. Although some firms have dropped their minimums to $250,000 (or even $25,000), this is still out of reach for most people.
Ways to Invest in Private Equity
There are a few non-direct ways to invest in private equity.
Fund of Funds
A fund of funds holds the shares of many private partnerships that invest in private equities. It provides a way for firms to increase cost-effectiveness and reduce their minimum investment requirement. This can also mean greater diversification since a fund of funds might invest in hundreds of companies representing many different phases of venture capital and industry sectors. In addition, because of its size and diversification, a fund of funds has the potential to offer less risk than you might experience with an individual privateequity investment.
Mutual funds have restrictions in terms of buying private equity directly due to the SEC's rules regardingilliquidsecurities holdings. The SEC guidelines for mutual funds allow up to 15% allocation to illiquid securities. Also, mutual funds typically have their own rulesrestricting investment in illiquid equity and debt securities. For this reason, mutual funds that invest in private equity are typically the fund of funds type.
The disadvantage is there is an additional layer of fees paid to the fund or funds manager. Minimum investments can be in the $100,000 to $250,000 range, and the manager may not let you participate unless you have a net worth between $1 million to $5 million.
PrivateEquity ETF
You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companiesinvesting in private equities. Since you are buying individual shares over the stock exchange, you don't have to worry about minimum investment requirements.
However, like a fund of funds, an ETF will add an extra layer of management expenses you might not encounter with a direct, privateequity investment. Also, depending on your brokerage, each time you buy or sell shares, you might have to pay a brokerage fee or commission.
SpecialPurpose Acquisition Companies (SPACs)
You can also invest in publicly traded shell companies that make private-equity investments in undervalued private companies, but they can be risky.The problem is that the SPACmight only invest in one company, which won't provide much diversification. They may also be under pressure to meet an investment deadline, as outlined in their IPO statement. This could make them take on an investment without doing theirdue diligence.
Crowdfunding
A recent development in private equity is the use of crowdfunding to raise capital, especially for new ventures, from individual investors, each contributing a relatively small amount. Today, there are several platforms offering a range of investment opportunities—but note that these investments can be highly risky.
If you participate in equity crowdfunding, make sure you do so as an investor and not as a donor (as in the case of Kickstarter-like crowdfunding platforms). Donating doesn't imply a hope for return, but investing does.
How Much Money Do You Need to Invest in Private Equity?
Although you may be able to find a private investment opportunity that requires as little as $25,000, a common private equity investment minimum is $25 million. However, there are some non-direct ways to invest in private equity for much less, such as buying a share of a private-equity ETF.
How Do I Get Into Private Equity?
There are several ways to branch into private equity investing, including through mutual funds, exchange-traded funds, SPACs, and crowdfunding. However, keep in mind that many private equity opportunities are only offered to qualified investors and may require a sizable minimum commitment as well as a high net worth.
How Risky Is Investing in Private Equity?
Private equity investing can be very speculative and therefore very risky. There is no guarantee the companies you invest in will succeed, and few protections for you if they fail.
The Bottom Line
There are several key risks in any private equity investing. As mentioned earlier, the fees of private-equity investments that cater to smaller investors can be higher than you would normally expect with conventional investments, such as mutual funds. This could reduce returns. Additionally, the moreprivateequity investing opens up to more people, the harder it could become for privateequity firms to locate excellent investment opportunities.
Plus, some of the privateequity investment vehiclesthathave lower minimum investment requirements do not have long histories for you to compare to other investments. You should also be prepared to commit your money for at least ten years; otherwise, you may lose out as companies emerge from the acquisition phase, become profitable, and are eventually sold.
Companies that specialize in certain industriescan carry additional risks. For instance, many firms invest only in hightechnology companies. Their risks can include:
- Technology risk:Will the technology work?
- Market risk:Will a new market develop for this technology?
- Company risk:Can management develop a successful strategy?
Despite its drawbacks, if you are willing to take a little more risk with 2% to 5% of your investment portfolio, the potential payoff of investing in private equity could be big.
