Unlocking Private Equity: Strategies For Smart Investing

Private equity is a form of investment that takes place outside of the public stock market, allowing investors to gain an ownership stake in private companies. Private equity funds are managed by private equity firms that oversee funds that invest in companies. Private equity is often grouped with venture capital and hedge funds as an alternative investment class.

Private equity funds may acquire private companies or public ones in their entirety, or invest in such buyouts as part of a consortium. They typically do not hold stakes in companies that remain listed on a stock exchange.

Private equity firms buy companies and implement changes to make them more profitable, before selling them again. This can include bringing in a new management team, adding complementary companies, aggressively cutting costs, or spinning off parts of the business that are underperforming.

The minimum investment in private equity funds is typically $25 million, although it can be as low as $250,000 or even $25,000 in some cases.

There are several ways to invest in private equity, including through mutual funds, exchange-traded funds (ETFs), and crowdfunding. However, many private equity opportunities are only offered to qualified investors and may require a sizable minimum commitment as well as a high net worth.

High minimum investment requirements

Private equity funds typically have very high minimum investment requirements, ranging from a few hundred thousand to several million dollars. As such, most private equity investing is reserved for institutional investors (such as pension funds or private equity firms) or high-net-worth individuals. The minimum investment in private equity funds is typically $25 million, although it can be as low as $250,000 or even $25,000. However, this is still out of reach for most people.

To be considered an accredited investor, you must meet certain net worth or income requirements. In the US, this means having a net worth of over $1 million or an annual income of $200,000 or more in each of the last two years.

There are a few non-direct ways to invest in private equity with lower minimums. One option is to invest in a fund of funds, which holds shares of many private partnerships that invest in private equities. The minimum investment for these can range from $100,000 to $250,000. Another option is to purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companies investing in private equities. There is no minimum investment requirement for buying individual shares on the stock exchange, but you will have to pay brokerage fees or commissions.

It's important to note that private equity investments are typically illiquid, meaning that investors must be prepared to hold their investment for the long term, often for at least 10 years. This is because private equity firms need time to implement their value-adding strategies and exit the investment.

Accredited investor status

To invest in top private equity, you need to be an accredited investor. An accredited investor is an individual or entity that meets certain wealth or annual income thresholds or holds relevant professional certifications. The accreditation requirement is meant to ensure that investors in private securities have either enough financial sophistication to evaluate the risks and merits of an investment or sufficient wealth to bear the economic consequences of a loss.

The U.S. Securities and Exchange Commission (SEC) restricts most private-market investments to two categories of investors: accredited investors and qualified purchasers. Accredited investors have to meet income and wealth thresholds set by the SEC or hold certain finance-sector certifications. A qualified purchaser is an individual or entity with at least $5 million in investments.

For an individual, accreditation is based on wealth, income qualifications, or financial expertise demonstrated through specific credentials or certifications. To be accredited, an individual must meet at least one of the following criteria:

• A net worth of over $1 million, excluding the value of a primary residence, either individually or jointly with a spouse or partner.
• An annual income of over $200,000 (individually) or $300,000 (joint income with a spouse or spousal equivalent) for at least the past two years, and the same is expected for the current year.
• Holds in good standing a securities representative license (Series 7), an investment adviser representative license (Series 65), or a private securities offerings representative license (Series 82).

For an institution, accreditation is determined by the institution type and the amount of assets under management. Examples of accredited institutions include entities with more than $5 million in total assets, such as corporations, partnerships, LLCs, trusts, charitable organizations, and family offices.

It's important to note that the criteria to become an accredited investor are rigid, and there is no federal verification process. It is up to each company to verify the accredited investor status of prospective partners before allowing them to invest. Accredited investors are typically required to provide income and net worth verification, such as bank and investment statements, proof of securities licensing or employment, and tax returns.

Private equity vs. public markets

Overview

Private equity is a form of investment that occurs outside of the public stock market, allowing investors to gain ownership stakes in private companies. In contrast, public markets refer to the trading of stocks or other financial instruments on centralised exchanges, such as stock exchanges. While private equity investments are typically made by institutional investors or high-net-worth individuals, public markets are more accessible to a wider range of investors, including retail investors.

Differences in Investment Opportunities

Private equity funds tend to invest in mature companies, seeking to add value through operational improvements, restructuring, or cost-cutting measures. They may also invest in early-stage startups with high growth potential through venture capital funding. On the other hand, public markets offer a broader range of investment opportunities, including stocks from companies across different industries and sectors, as well as other financial instruments such as bonds, commodities, and derivatives.

Liquidity and Risk

Private equity investments are generally less liquid than public market investments. Private equity investors typically need to hold their investments for longer periods, often exceeding ten years. Additionally, private equity investments are considered riskier due to the lack of transparency and regulation compared to public markets. Private companies are not subject to the same strict accounting practices and public disclosure requirements as publicly traded companies.

Returns and Performance

Private equity investments have historically offered the potential for higher returns compared to public market investments. Private equity firms aim to generate profits by improving the operations and performance of the companies they invest in and then selling them at a profit. However, public market investments may provide more stable and predictable returns, especially for well-established companies with strong track records.

Access and Investor Requirements

Investing in private equity typically requires a substantial amount of capital, with minimum investment requirements ranging from hundreds of thousands to millions of dollars. Private equity funds are primarily accessible to institutional investors, such as pension funds, and high-net-worth individuals who meet the criteria of accredited investors. In contrast, public markets are more accessible to a wider range of investors, including retail investors, who can buy and sell stocks through brokerage platforms or other investment vehicles.

Private equity platforms

Private equity groups may create up to six platforms for each fund, and they are grown organically before bolt-on acquisitions are added to each platform company.

A private equity platform will be a top player in its industry, employing innovative systems that give it an advantage over its competitors. It will have strong and experienced management, with executives who have a proven track record in a specific industry and the ability to direct operations effectively.

Private equity groups use capital from limited partners or investors to grow their platforms, acquiring other companies or "add-ons" in a related industry. As the platform acquires these add-ons, its value increases, and after 3-7 years, the private equity group will sell the platform at a higher value.

There are several ways to grow a platform, including organic growth, mergers and acquisitions, increasing the density of operations in a given geographical location, and expanding the existing service area.

Mergers and acquisitions far outperform organic growth. One of the best ways a private equity group can grow a platform is by acquiring businesses that fulfil its strategic needs. For example, if a private equity group acquires a medical company, it may use that company as a platform to acquire a manufacturer of medical equipment, thus fulfilling the needs of technicians within the company and eliminating certain costs.

Another way to grow a platform is by acquiring other companies in the same industry, thus reducing competition and costs associated with employee travel time.

The purpose of a platform company is rapid growth, and the singular goal of a private equity group is to provide the maximum amount of return to its partners.

Private equity funds

There are several different ways to invest in private equity funds, including directly investing in the fund itself or investing in exchange-traded funds (ETFs) that provide access to publicly traded private equity firms.

Frequently asked questions