Private equity is one of the hottest sectors of alternative investing. It allows startups and early stage companies to raise capital by offering equity to investors who want to get in on the ground floor. As recently as 15 years ago, investing in private equity was almost exclusively the domain of the very wealthy.
However, new technological developments like online equity crowdfunding platforms are opening up the world of private equity investing to individual investors. Is private equity right for you? Keep reading to find out.
What is Private Equity?
If you’re into investing or follow investment news, you hear the term private equity a lot. However, many people still don’t know exactly what private equity is. Whenever investors buy stock in a company or a piece of real estate, they’re getting equity in exchange for their purchase. When the stock or investment offering they buy is available on the open market - stocks, exchange-traded funds (ETFs), real estate investment trusts (REITs) - to investors, it’s known as a publicly traded offering.
Investment offerings that are not available on the public market such as publicly traded exchanges are known as private equity offerings. These are investments made in a private company that are made through private markets. Basically, the investor is getting equity in a private investment opportunity that’s not available to the public. Because most private equity offerings carry high minimum investment requirements, most of them are only available to institutional investors, like a hedge fund or pension fund, or accredited investors. However, the right private equity investment can turbocharge the value of your portfolio.
How Does Private Equity Work?
Private equity offerings are usually only available through a private equity fund (PE funds) or a private equity firm (PE firms) that targets high-net-worth individuals. In exchange for their investment, private equity investors get early equity in the offering as preferred shareholders. If the offering performs as expected, these preferred shareholders will have purchased a massive amount of equity for pennies on the dollar in comparison to the cost of buying publicly traded stock in that company.
Generally, when investors participate in a private equity offering, they gain limited partnership in an investment fund or the company itself. As limited partners, investors get an ownership stake in the fund or company, but unlike voting shareholders, they don’t make management decisions or manage day-to-day operations. Management decisions are made by the fund manager, general partner or CEO of the company.
Private equity firms typically focus on a particular business sector, and the general partner or fund manager has a wealth of experience and contacts in that field. Examples of the sectors that can be targeted by private equity funds include:
- Biotech
- Technology
- Real estate
- Startups
- Social media companies
Why Do New Businesses Raise Money Through Private Equity?
Capital is the lifeblood of every new business. Regardless of what sector it is in or what the business goals are, it can’t get itself off the ground without money. The traditional methods of raising business capital are borrowing from financial institutions or making stock offerings.
However, startups and early stage companies usually lack the collateral necessary to secure bank loans, and they don’t meet the requirements for being publicly traded. So, when they can’t raise capital through bank loans or stock sales, they seek funding through private equity. This allows the startup to get the growth capital it needs to establish itself, while at the same time offering private equity investors or funds an enticing financial opportunity.
Why Do Investors Make Private Equity Investments?
The simple reason why investors and funds make private equity investments is upside. Very few publicly traded stocks offer the profit potential that private equity offerings do. Once most companies have equity shares available on the stock market, it’s a free for all.
Buying private equity on the other hand is more like buying advance tickets to a rock show vs. buying them at the door. You get better seats for less money. On the day of the show, you can keep them or sell them at a profit. Except of course, the rewards for investors are much larger than getting good seats.
For example, before companies like Alphabet Inc. (NASDAQ: GOOGL) or Meta Platforms Inc. (NASDAQ: FB) became household names and titans in the stock market, their operations were funded by private equity investors. Those early investors have made millions, if not hundreds of millions of dollars on their investments. Additionally, the cost of buying the kind of equity that original private equity investors have in those companies today would be prohibitive.
Even if you had enough money to buy that much of Google or Meta on the stock exchange, it’s highly unlikely you can get the kind of return on investment that the original private equity investors got. All this potential upside is why private equity is such a popular alternative investment.
How to Invest in Private Equity Offerings
Before you can participate in a private equity offering, you will most likely have to be an accredited investor. Most private equity offerings have large buy-ins. However if you meet that requirement, these are the most common ways to make private equity investments.
Private Equity Firms
A private equity firm invests almost exclusively in startups and raises investor capital to increase the size of its portfolio. The braintrust at private equity firms usually has connections in whatever business sector the firm specializes in.
Once you’ve chosen a firm, the firm’s management will present offerings to you based on your investment goals and risk tolerance. You will have some control over where you put your money, but the buy-ins here can be prohibitively high and once your money is in, you’re no longer in control.
Private Equity Funds
Many institutional funds and mutual funds specialize in private equity. If you buy into one of them, you become a limited partner in the companies they invest in.
As a limited partner, you have equity in the offering but no direct say in how the fund is managed or what investments it makes. You basically hand your money over to the fund and trust the general partner to make the right decisions.
Limited Liability Partnerships
You buy into these are private equity offerings with other like-minded investors. Limited liability partnerships usually focus on a single investment or business in need of capital.
Your equity share will be proportional to the amount of your individual investment; however, you will still be a limited partner. Although you can choose what partnership you buy into, the general partner will still be piloting the ship.
The biggest difference between this and a fund is that you’re usually buying into one particular investment as opposed to a mixed bag of pre-selected private equity offerings.
Online Investment and Crowdfunding Platforms
Years ago, you had to be connected to important people to even know when a private equity offering was available. Thankfully, the internet has changed all that through the advent of online crowdfunding platforms.
These platforms are a virtual marketplace that is full of private equity offerings in all sectors. One of the advantages of making private equity investments through online crowdfunding platforms is that the platforms are usually run by experienced and savvy business people who perform a high level of due diligence on all proposals before clearing them to appear on the platform.
This practice doesn’t mean there isn’t a risk of loss, but it does mean that someone who has a proven track record of business experience has vetted the offering. You can find some great private equity opportunities by taking a look at this list of Benzinga’s favorite startup crowdfunding platforms.
Private Equity Exchange-Traded Funds (ETFs)
When it comes to most private equity offerings, the buy-ins can be as high as seven figures. However, private equity ETFs are funds that offer investors a chance to buy publicly traded shares in a fund that has a bundle of highly diversified private equity shares in multiple startups at the same time.
ETFs can offer a lower buy-in, meaning there is the potential for non-accredited investors to get in on the act. However, ETFs carry other costs, such as broker fees and load fees that you wouldn’t necessarily have to pay if you bought private equity shares directly through a firm.
Private Equity Real Estate Opportunities
Although most people associate private equity investments with the tech sector, real estate holds many private equity opportunities. The difference is that as opposed to investing in individual companies, you’ll be putting your money into specific real estate projects or developments that need investor capital.
Once your investment is made, you will typically become a limited partner in the particular real estate projects that are part of the offering. The general partner makes all the decisions, so you need to choose carefully.
Private equity real estate opportunities also usually have long hold periods where your investment capital is illiquid. Under most circumstances, profits come when the development is completed and sold.
Explore Benzinga's favorite private equity real estate investment offerings.
Venture Capital
Venture capitalists usually provide private equity for businesses and startups in the tech sector. Traditionally, venture capital opportunities have been restricted to a tight network of well-connected investors who have pre-existing personal connections to the venture capitalists themselves.
However, the intense volume of capital required to finance tech startups has led to an expansion of venture capital opportunities. Now venture capital funds (VC funds) and online trading platforms offer these opportunities.
How Do Private Equity Investors Make Money?
The allure of private equity investments is that they give investors an opportunity to buy early equity in new companies or other business opportunities. Under most circumstances, the equity is poured into the business for a designated hold period - usually between 3 to 5 years - while the business grows itself.
In a perfect world, the business will use investor capital to grow its operations, advertise and seek out new clients. If that happens, the business grows and gets to a point where it meets the U.S. Securities and Exchange Commission (SEC) requirements to be publicly traded at an initial public offering (IPO).
Once the IPO happens, investors who provided the startup capital may benefit from a dramatic increase in the value of their early equity. They can hopefully sell their shares at a massive profit or continue on as equity owners in the company. In the case of a private equity real estate offering, when the project is completed the investors can sell it off, hopefully for more than the original investment capital amount.
Remember, though, that not all early equity investments work out. Some businesses fail and others take too long to get off the ground. You should keep in mind the trajectory of the business when making your investment.
What are the Risks Involved With Private Equity Investments?
Private equity investments are popular because of the upside they offer. It’s possible for one successful private equity investment to make you rich beyond your wildest dreams and set up generational wealth for your family. However, all that upside translates to increased risk.
In almost all cases, the companies seeking to raise private equity have no track record of success, and that kind of risk is enough to scare off institutional lenders like banks. If you want to play the private equity game, you need to be prepared for the likelihood of losing money.
In addition to the risk of loss, private equity investors must be able to withstand having their investment capital be illiquid for an extended period of time. Unlike stocks, no public exchange or market exists where private equity shares can be liquidated, so you must be prepared to give up access to your investment capital for years at a time.
If you’ve invested into a private equity ETF, venture capital fund or real estate venture, you have an ownership stake without a voice. You, and your investment capital, are completely in the hands of the fund manager or general partner. You’ve got to be really certain of their ability to deliver on their stated goals.
Is Private Equity Investing Right for You?
It’s easy to see why private equity is one of the hottest sectors in alternative investing. The tech boom and the rise of social media empires have created a lot of opportunities for people to multiply their investment capital exponentially in a short period of time. That’s why so many hedge funds and mutual funds are making strong moves into the private equity sector.
The high risk and long-term illiquidity involved with making private equity investments means individual investors should be wary of building their entire investment portfolio around them. Even the institutional funds that are involved with private equity have highly diversified portfolios, which should be instructional to individual investors.
Private equity has a lot of opportunity, but whether it’s right for you depends on a number of factors. Your overall investment strategy, risk tolerance and ability to have an investment be illiquid for a long time will both go a long way towards determining if private equity investing is right for you and how you invest in private equity offerings. The good news is that you can use Benzinga as a resource for your investment goals.
Frequently Asked Questions
Is private equity a safe investment?
The short answer to that question is that all investments carry an element of risk and none of them are truly safe in the sense that you can’t lose by making this particular investment. No matter how reliably an investment has performed, there is always a risk of loss. With that said, private equity investing has a higher degree of risk than many other alternative investments such as real estate, precious metals.
That’s because private equity involves buying equity in unproven companies or underperforming assets in the hopes that the equity will appreciate in value in the future. You’re basically buying equity in businesses or real estate assets that financial institutions won’t lend to because of the risk factor involved. However, a significant potential financial upside comes with the risk, and the right private equity investment can literally set you up for life.
How do you make money from private equity?
When you make a private equity investment, you are buying equity in a company or an asset that needs to raise capital but can’t secure financing through a bank loan or a stock offering. Most often the companies that raise funds through private equity are startups or in very early stages of their development.
If the company performs as expected, it will progress to a point where it meets the requirements set by the SEC for an IPO. At that point, the original value of the equity purchased in the private equity agreement will explode in value. Then private equity investors liquidate their shares, take their profits and look for another private equity opportunity.
In the case of a private equity real estate investment, if the asset begins experiencing revenue growth from upgrades and progressive management, it is likely to appreciate in value and be sold at a profit. Investors take their profits and look for another asset to purchase.
Can anyone invest in a private equity fund?
No, not everyone can invest in a private equity fund. Private equity funds are typically limited to high-net-worth individuals, institutional investors, and accredited investors who meet certain income or net worth requirements. This is because private equity funds involve higher risks and require a significant amount of capital. Additionally, private equity funds are often subject to regulatory restrictions and may have minimum investment requirements.
About Eric McConnell
Eric McConnell is an alternative investment writer interested in rare collectibles, fine wines, art and sports memorabilia. He developed his love for sports during his childhood, where in addition to being an aspiring professional baseball player, he was an avid baseball card collector and reader of the Robb Report.
As is the case for many aspiring young sluggers, Eric’s baseball career came to an end the first time he encountered a pitcher capable of throwing 90 mph and a wicked curveball. However, his delight in the finer things of life never waned, and after a career in real estate, Eric branched out into writing, where he joined Benzinga as an alternative investment writer in 2021.
Although he covers breaking news in all areas of alternative investments, Eric’s favorite subjects harken back to his childhood days of reading the Robb Report and collecting baseball cards. He has a passion for writing about fine art sales, whiskey auctions and sports memorabilia.