The idea of getting access to investments that other people don’t normally see can be alluring. After all, these types of investments aren’t widely available, and you have a chance to beat the stock market. Private equity investment is often seen as one of these opportunities.
But what is private equity investment? It’s an investment in a business that’s not available on a stock exchange. As an alternative investment, private equity investing is also often considered riskier but potentially more rewarding.
Not everyone is eligible to invest in private equity, however. We’ll explore the ins and outs of this type of investing and how and if you can get started.
What is private equity investment?
A private equity investment is one that allows you ownership of an asset that is generally only available on private markets.
Equity doesn’t always refer to stocks, although the two terms are sometimes used to mean the same thing. When considering equities versus stocks, remember that a stock represents a share of ownership in a company and is a type of equity.
There are other types of equity, such as owning a portion of a real estate development or becoming a limited partner of private companies. It’s also possible to own shares of private equity funds that include a variety of private investments.
Other types of private equity include loans to companies that have filed for bankruptcy and venture capital funding.
Are private equities easy to access?
The main idea behind private equity is that it’s not widely available, and you can’t purchase shares or interest in the asset on a public exchange. With stocks, almost anyone who is at least 18 can use a broker to access a stock exchange.
It’s also important to note that private equity investments aren’t usually registered with the Securities and Exchange Commission (SEC) and aren’t subject to the same disclosure requirements that public companies must adhere to.
Even if the advisor associated with a private equity investment is registered with the SEC, the investment itself doesn’t have to be. That means some information might not be publicly available.
Who can access private equities?
Because of the higher risk that comes with investing in private equity, there are usually limitations on who can participate in these investments.
In many cases, you must be an accredited investor to participate in private equity investments. The SEC considers many of these investments to come with higher risks due to the lack of disclosure.
An accredited investor is assumed to have the financial risk tolerance or knowledge necessary to absorb some of these risks. As an individual, the SEC requires you to meet at least one of the following conditions to be considered an accredited investor:
Earn more than $200,000 per year in earned income (or $300,000 with a spouse) for the last two years, with an expectation that you will make over $200,000 in the current year.
Have a net worth of at least $1 million on your own or with your spouse — not including the value of your primary residence.
Hold a series 7, 65, or 82 financial license.
Access to private equities is also determined by how much money you can invest. Many of these types of investments require a high minimum contribution. For instance, you might need to commit hundreds of thousands of dollars or more to buy into a private equity investment or fund.
Some private equity investments have minimum commitments as long as 10 years or more. You may need to be willing to lock up your money for several years.
How to invest in private equity
If you’re interested in investing money in private equity, you need to prepare ahead of time and make sure you meet the requirements, especially if you’re relying on your net worth criteria. Here are the steps you can follow to invest in private equity.
1. Become an accredited investor
First of all, you need to take steps to become an accredited investor. If you hold one of the approved financial professional licenses you will be considered eligible. You need to maintain your good standing with the license in order to retain your status.
Next, a private equity company or fund manager will likely require you to provide documentation of your accredited investor status. If you’re using the income requirement, you will need to provide pay stubs and tax returns. If you’re using your net worth requirement, you will have to provide investment, bank account, loan, and other liability statements.
Your primary residence also can’t be used to determine your net worth. Your mortgage only matters if you’re upside down, in which case the amount you owe beyond the value of your home will be considered a liability.
Finally, any increase in your loan balance will be considered a liability. The SEC doesn’t use home equity loans or lines to identify high-net-worth individuals.
2. Select a private equity company
Once you’ve established that you’re an accredited investor, you can begin looking for a private equity company to invest in. You can use special portfolio companies or advisors to help you look.
Some companies — including Goldman Sachs and Blackstone — offer the opportunity to invest in a private equity fund. These are funds of funds similar to hedge funds and mutual funds, where the money from investors is pooled together and invested into private equity.
Don’t forget to research the time horizon for the investment. You might need to lock up your money for two, three, or even 10 or more years, depending on the terms involved. This is especially true if you decide to buy into a private equity fund.
3. Research potential investments
It’s always important to do your due diligence anytime you invest, whether it’s a publicly traded company or a private equity opportunity. All investment comes with risk, and private equity can have higher risks resulting in large losses.
Research opportunities that make sense for you. Consider your interest and knowledge. You might be able to invest in a small, early-stage startup and profit if the company grows over time, especially if it eventually goes public. You could potentially invest in a business partnership and receive regular income.
Private equity real estate investments are also available. Some are structured as debt financing investments, while others offer a share of ownership in the project.
If you want an easier private equity opportunity, you can look for a private equity fund managed by a well-known or successful advisor. These funds are pooled investments where you put in the minimum required amount of money, and a manager identifies private equity opportunities to add to the fund.
They do the heavy lifting of choosing different investments, and you reap the potential profits.
4. Track your progress
Pay attention to the progress you’re making. Realize that it can take several years or longer to see a meaningful return on your investment. In some cases, private equity funds actually require a holding period of at least 10 years.
Keep an eye on performance and read any reports that come your way. Realize that you run the risk of being unable to access your money while it’s committed to a private equity investment.
Other risks include the possibility that a fund manager has a conflict of interest, a private equity project fails, or you get scammed by an unscrupulous party.
It’s important to research investment minimums. Some private equity opportunities might be available with a minimum of $100,000 or $250,000, while others require at least $1 million.
3 reasons to invest in private equity
Even though there are risks to investing in private equity, it can make sense if it fits your portfolio strategy and risk tolerance. Here are some of the benefits of investing in private equity.
1. Potential for big gains
When you invest in private equity, especially with a startup or certain real estate projects, you have the potential for market-beating gains. That’s because private equity projects and companies can offer double-digit returns through fundraising and capital investments not often seen consistently in public markets.
2. Access to exclusive projects
Exclusive projects have the potential to diversify your portfolio with an asset class that is not generally available. You have an inside track on what might be successful and profitable in the future — something most investors don’t have access to.
3. Profit from a buyout
If you invest as a limited partner in a company, you have the potential to benefit from a buyout strategy. Some companies get started with the intention to raise capital and then attract someone else to buy them out.
If you’re a limited partner, you might not be managing the day-to-day operations, but you’re entitled to a portion of the buyout money if it comes. While these can be enticing benefits, it’s important to remember that there is also a higher risk of loss with private equity.
Not all companies are successful, a leveraged buyout strategy might not come to fruition, or you could lose money after having your investment funds locked up and inaccessible for years. Carefully weigh the drawbacks against the potential benefits before you move forward.
Alternative options to private equity investment
If you can’t access private equity investment opportunities, there are other ways to add alternative assets to your portfolio. Depending on your situation, you might be able to buy private equity ETFs offered by publicly traded companies.
Additionally, there are platforms like EquityZen, YieldStreet, and Fundrise that have lower minimums for some private equity opportunities. While there are some investments that are only available to accredited investors, these platforms also offer investments to those who aren’t accredited.
You can also skip private equity investments entirely and sign up with one of the best online broker accounts instead. These accounts let you invest in publicly traded assets.
Are private equity funds good investments?
A private equity fund can provide access to a high rate of return and could be a good addition to an investment portfolio. However, there’s always the risk of loss, and private equity’s high minimum investments and time requirements mean that they could be more challenging for inexperienced investors.
Is investing in private equity risky?
All investment comes with the risk of loss, but private equities are generally considered to carry a higher risk than more traditional investments like stocks and bonds.
Private equity investors often face the potential for bigger losses, especially if a project fails. This is because these investment professionals often need to put more money into a private equity investment than they would with publicly traded investments like an initial public offering.
What does a private equity company do?
A private equity firm looks for other companies or projects to invest in. They hope to see high returns by creating a management team to run the company and improve its cash flow, or by investing in projects that have high growth potential.
Private equity investments aren’t available to everyone. However, if you qualify, you might be able to see high returns — as long as you have a high risk tolerance and can absorb potential losses.
As with any investment, it’s important to carefully consider your long-term financial goals and investment strategy and avoid investing more money than you can afford to lose.
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This article What is a Private Equity Investment? (and How to Get Started) originally appeared on FinanceBuzz.