If you’ve ever wondered how high-net-worth individuals and powerful institutions generate such significant, long-term returns by investing in businesses outside public markets, private equity will be a big part of that answer. Historically reserved for the ultra-wealthy and large institutions, private equity is now increasingly accessible to individual investors through innovative fund structures and fintech platforms. This article looks at what private equity investing is, the pros and cons of getting involved, and some practical ways investors without millions in up-front capital can now participate.
What is Private Equity Investing?
Private equity refers to investing directly in private companies (businesses not listed on stock exchanges), or taking existing public companies into private ownership to improve their operations before selling them later at a profit. Private equity investors provide capital in return for ownership stakes, then work to increase the value of those companies over several years before exiting through either a private sale or IPO.
Key terms:
IPO (Initial Public Offering) is the first time a private company offers its shares to the public by listing them on a stock exchange. This allows the company to raise capital from public investors, and gives early investors and founders a chance to sell some of their ownership in the company.
Accredited Investors are individuals or corporate entities that meet certain financial criteria set by regulators, allowing them to invest in higher-risk or less-regulated investment opportunities, such as private equity, hedge funds, and venture capital. For example, in the United States the criteria set by the Securities & Exchange Commission is an annual income exceeding $200k and a net worth exceeding $1 million (excluding their primary residence).
Advantages of Private Equity Investing for Individuals
- High potential returns: Private equity has historically outperformed public equities over long periods due to hands-on management and value creation at the company level. Top-performing funds can deliver double-digit annualized returns.
- Diversification beyond public markets: Private equity investments don’t move in direct alignment with stock markets, which can help smooth out portfolio volatility as well as increase diversification.
- Innovation & growth: Private equity can give investors access to high-growth businesses long before they appear on stock exchanges. This can include innovative startups, niche industries, and sectors like green energy.
- Professional management: Private equity funds are managed by experienced teams that actively improve the operations, finances, and strategies of their portfolio companies. Investors can therefore indirectly benefit from this expertise.
Disadvantages
- Reduced liquidity: Private equity is a long-term commitment. Funds often lock-up capital for years, and investors may not be able to sell early without a steep discount. Limited liquidity is one of the biggest drawbacks of private equity investment.
- High fees: Private equity funds often charge a “2 and 20” model, which is a 2% annual management fee + 20% of profits. Even newer retail-oriented products can still be relatively expensive.
- Regulatory limitations: In many jurisdictions, full access to private equity remains limited to accredited investors. While this is changing, many opportunities in private equity remain restricted.
- Complex structures: Understanding concepts such as capital calls, distributions, and internal rate of return can be challenging for new investors. While those investing in listed private equity trusts (discussed below) don’t need to personally manage or experience capital calls, distributions, or internal rate of return calculations, as these are handled by the fund’s managers, having a basic understanding of these concepts can still help investors interpret performance and risk more intelligently.
Key terms:
Capital calls: In private equity, investors commit a total amount of capital, which the fund calls (requests) over time as investments are made. Understanding timing and obligations is important.
Distributions: Returns are typically paid out in stages when portfolio companies generate cash or are sold.
Internal rate of return: This is the standard metric used to measure performance in private equity, accounting for the timing of capital calls and distributions.
Ways Retail Investors Can Access Private Equity
Although this asset class has traditionally been the domain of accredited investors and large institutions, this has recently begun to change and private equity is no longer the closed club it once was. Individuals can now access private equity through various new ways (some of which are listed below) which have helped to lower minimum investment thresholds dramatically. Below are some of the most practical ways individuals can now access private equity: from fintech platforms to exchange-listed investment trusts.
- Listed private equity trusts: These investment trusts, which are traded on stock exchanges, offer access to diversified portfolios of private companies. Examples include Pantheon International, HarbourVest Global Private Equity, and HgCapital Trust. As their shares can be bought and sold on exchanges like shares, they offer far better liquidity than traditional private equity. However, it should be kept in mind that prices can fluctuate, and therefore trade at prices above or below net asset value.
- Secondary market platforms: Platforms such as Forge Global and EquityZen allow investors to buy shares of late-stage private companies before they go public. This enables shorter holding periods, and the potential for improved liquidity if the company IPOs.
- Venture capital & startup platforms: For investors comfortable with greater risks, equity crowdfunding platforms like Start Engine, Republic, and Crowdcube enable direct investment in early-stage startups. Minimums can start as low as $100, creating a widely-accessible entry point for investors combined with a choice of interesting companies to invest in.
- Access funds (a.k.a. feeder funds): These funds pool smaller investors’ capital to meet the high minimums of institutional private equity funds. Firms like Moonfare and Titanbay provide curated access to top-tier managers.
- Funds of funds: These are investment vehicles that invest in a portfolio of other funds. In the context of private equity, these funds of funds pool investor capital and allocate it across multiple private equity funds, giving investors diversification across managers, strategies, and sectors.
- Private equity focused mutual funds: Some mutual funds invest in private equity firms. While this doesn’t offer direct access to private equity, it does provide an indirect method of taping into similar themes in a way that is well-regulated and benefits from better liquidity as shares in these mutual funds can usually be redeemed for cash directly with the fund company, offering better liquidity than traditional private equity investments.
- Private credit: Platforms like Percent allow investors access to private credit too with a minimum investment of $500. Mixing private credit and private equity can generate both steady income and long-term capital growth, as well as smoothing out a portfolio’s overall volatility. Although Percent offers a low minimum investment, this investment platform is nevertheless exclusively reserved for accredited investors.
Conclusion
If investors can successfully navigate the complexity, private equity can be a rewarding addition to a well-diversified portfolio. However, it is not for the fainthearted. Investors should carefully consider time horizon, liquidity issues, and risk tolerance before committing. While private equity has historically delivered attractive returns, these can never be guaranteed and private equity can involve complex structures that lock-up capital for considerable amounts of time.
Though some areas of private markets remain restricted to accredited investors, the trend towards increasingly democratized access is making it easier than ever before for individuals seeking to invest in businesses while diversifying beyond public markets to participate.
Disclaimer: Past performance is not indicative of future returns. The purpose of this website is education and financial journalism. It is not a recommendation or personalized financial advice. Your personal circumstances have not been taken into account, and this website is not a substitute for consulting a qualified financial advisor. All images are for illustrative purposes only.