Making profits via investment is possible in numerous different ways. Other than the conventional forms of raising profits via stock or share investments, private equity is an alternative form that is increasing in popularity now. Let us see what the term means, its functionality, and how you can turn it into an advantageous investment.
What Is Private Equity (PE)?
This is an alternative form of asset realization that includes funds that are not listed publicly in the stock exchanges. It denotes the shares that are part of the company’s ownership claim.
So, if you are interested in taking a partial stake in a company that shows high growth and profit potential in the long term, you can do a private equity investment in the company.
Fundamentally there are three important components in private equity:
- The investor
- The company you want to invest in
- An intermediary that helps manage the investment through a special fund
However not every individual can consider this alternative investment as you need substantial sums to own such assets. They are mostly HNIs (High Net worth Individuals), PE companies, and institutional investors who consider this type of fund. And they consider this type of investment as it helps the private company involved to
- Expand or diversify
- Undergo restructuring or innovation to increase its competitiveness
- Enable acquisition
In some instances, a public firm that wants to become private can lure PE investors and devise strategies for its future growth.
How Does Private Equity Work?
The working method of PE is best explained by the following example. For instance, you are willing to invest $2 million via a PE firm. Remember that the minimum amount is always high in PE. Furthermore, to become an accredited PE investor you should have a net worth of over $1 million or earn an annual income of over $200,000 for the previous two years.
The firm that helps you invest will add your money to a PE fund which already has several other investors. The money collected this way is utilized by the firm to invest in several PE instruments like venture capital, buyouts, etc.
Pros And Cons Of Private Equity
As with any other fund, PE also has its share of advantages and risks. Let us see what they are here.
- It helps investors to diversify holdings.
- Provides a better opportunity for returns when compared to a public market environment.
- Businesses favor PE funds as they provide them with vast resources for diversification and growth with minimal restrictions.
- PE firms not only provide funds for businesses but also provide expertise to the companies thus increasing their value.
- The companies that you invest the PE funds in should have capable systems and operations to grow and deliver the returns failing which you stand to lose your funds.
- Upon investing, all the money is locked for a certain duration so you will not have access to the fund during this time.
- In contrast to public markets, there are no ready sellers or buyers present to liquidate the funds in the PE holding.
- The share prices are fixed by the negotiations that occur between the sellers and buyers and not by the market forces.
- There is no established framework for the rights of the PE stakeholders as in the public market holdings.
- Even PE funds are subject to market conditions like geopolitical events, interest rates, foreign exchange rates, etc. This is because such changes influence industry trends which in turn affect your funds.
3 Ways To Invest In Private Equity
To invest directly in a PE, you have to collaborate with a PE firm. The selection of the firm depends on factors, such as:
- Investment minimum set by the firm
- Field of expertise
- Schedules the firm has for fundraising
- Exit strategies in place
Some of the prevalent methods of PE investment are given below:
#1 Private Equity Exchange Traded Funds
Such funds follow an index comprising of publicly traded firms investing in PEs. This is a simplified form where you get to buy the funds directly from a stock exchange.
And there are no minimum investment regulations here. But you have to pay a fee towards management and broker charges.
#2 Private Equity Fund of Funds
This form includes shares from different private partnerships that invest in PEs. For those who are looking at a reduced minimum investment, this is a good option.
It is also effective for diversifying your portfolio. It can be used as a hedging tool as you get to invest in a diverse range of firms belonging to different industry segments.
#3 Private Equity Crowdfunding
This form includes generating funding via securities sales like debts, convertible notes, and shares. Startups, entrepreneurs, and small businesses use this method to obtain capital for their business. An investor gets equity interest or partially owns the business. Some common platforms of this type include Localstake, SeedInvest, etc.
The above are not the only forms available. You can also earn profits by buying shares (public) of a PE firm or manager. Such shares give you access to PE funds and help diversify your portfolio and gain the benefits associated with such shares. But this type does not provide as many returns as directly investing in a PE fund.
Now that you know all the pertinent facts about private equity, you can consider it for your investment portfolio. After making the necessary assessments given the various pros and cons related to it, you can arrive at an informed decision.
While the risks are substantial in private equity due to the high sum you need to put in. Even if there are relaxations done on the minimum amount to invest, it can make it difficult for the PE firms to find good opportunities for investing the funds.
However, if you allocate just around 5% or less of your portfolio to private equity, you can reduce the perils associated with this type of funding and earn potentially lucrative returns.