What is private equity investing?
Private equity is a type of alternative investment that occurs outside the public stock market. In private equity investing, investors buy an ownership stake in private companies. Private equity investing allows investors and institutional firms to diversify their portfolios. In this way, they can take calculated risks with the hope to earn higher returns.
In private equity investing, there are three main parties:
- The investors who buy an ownership stake in private companies
- The private equity firm that manages and invests the money provided by the investors
- The companies in which the investors invest via the private equity firm
How does private equity investing work?
Let us understand this with the help of an example.
Let us say Mr. A invests $5 million through a private equity firm. The private equity firm would then put this money in a private equity fund. A private equity fund is a special vehicle created by a private equity firm. It acts as a pool of money where all the money invested by different investors is put. There are different types of private equity funds based on the investment avenues they put their money in.
However, Mr. A would have to meet the minimum investment criterion to participate in private equity investing. He would also have to be an accredited investor. That means his net worth (individual or with a spouse) should be over $1 million or his annual income should be higher than $200,000 in each of the previous two years.
What are the different types of private equity investments?
The private equity firm uses the investors’ contribution in various ways to earn profit. It all depends on the types of deals the firm is a specialist in.
Here are the four common types of private equity investments:
Distressed funding means investing in struggling businesses. These businesses have already filed for Chapter 11 bankruptcy. When such companies receive distressed funding, they can focus on restructuring their business models. In this way, they can plan a repayment strategy for their loans.
In few cases, private equity firms assist these businesses by restructuring their management to turn these businesses around. In other cases, distressed funding is mainly about selling the stressed business’ assets to earn profit.
When a private equity firm buys a target company to sell it later for a profit, it is called as a buyout. The target company can be public or private. Most of the time, private equity firms use capital from private equity fund.
However, they may also borrow money to seal the buyout deal. They then utilize the assets of the target company to secure the loan. In such a case, the buyout is termed as a leveraged buyout.
In a buyout, the private equity firm chooses a company that has scope for improvement. The private equity firm buys it and brings changes in its operations or management. It then turns the company around and sells it later for a profit.
Buyouts intend to invest in mature companies. However, in venture capital, the private equity firm identifies early-stage startups that need funding. These startups raise cash from private equity firms and give them a portion of their equity.
The goal of venture capitalists is to invest in companies promising high growth potential. These companies can then go public through an initial public offering (IPO). After an IPO, the ownership stake can get converted into shares. The venture capitalists can then sell these shares in the public market for a profit.
Specialized limited partnerships
Few private equity firms manage funds that invest in certain types of assets. For instance, real estate is one such asset. The private equity firm can then invest in commercial spaces, or in apartment buildings. Other private equity funds may also invest in infrastructure projects such as bridges and roadways.
Are there any cheaper ways of private equity investing?
Traditional private equity has certain requirements such as minimum high net worth. However, there are a few cheaper ways of private equity investing.
Angel investors are well-groomed entrepreneurs or knowledgeable professionals. They put their money into promising start-ups in exchange for an ownership stake. In this way, the startups get the seed money to set up their business.
In equity crowdfunding, a private business uses an online platform to raise money from many individuals. These individuals are also known as private equity crowd-funders. In this type of private equity investing, the minimum contribution can be as low as $2,000. Moreover, these crowdfunding platforms need to comply with Securities and Exchange Commission (SEC) regulations.
Fund of funds
A fund of funds is a pooled investment fund. It invests in other funds such as mutual funds and hedge funds. Its pricing is like mutual funds and its investing threshold is also quite low.
Private equity exchange-traded funds (ETFs)
A private equity ETF mainly invests in private companies. Investment companies such as Invesco (the Invesco Global Listed Private Equity Portfolio) and ProShares (the ProShares Global Listed Private Equity Portfolio) sponsor these ETFs.
What are the challenges in private equity investing?
To witness a return on private equity investment, one may have to hold it for a long term, maybe 10 years. Thus, illiquidity is one of the major cons of private equity investing.
Lack of transparency, regulation, and historical company data
Private equity funds are not registered with SEC. So, private equity firms are not obliged to publicly disclose information about their funds.
Additionally, privately held companies, that are the targets of private equity firms, are not subject to public scrutiny. It is a private equity firm’s responsibility to identify companies with sound financial health. Thus, there exists a good amount of risk in private equity investing.
Moreover, in a buyout, mature companies may disclose data related to their historical earnings and operations. But an early-stage startup may have very little information of that sort. This makes investing in a new startup through venture capital riskier than investing in a mature company.
Nonetheless, private equity investing is indeed a great investment option.
To explore the benefits offered by private equity investing, Investable Universe is a name you can trust upon. Silver lake investors is a global private equity firm that invests in technology and technology-related industries. Founded in 1999, it is one of the largest private equity firms in the US. Silver lake investors currently has more than $79 billion worth of assets under management. It is present in North America, Europe, and Asia.