Private equity (PE) is an asset class focused on investing in private companies.(1). It’s traditionally been reserved for institutional investors and high-net-worth individuals, with limited access for regular investors. However, access is slowly expanding through crowdfunding platforms and private equity exchange-traded funds (ETFs).
Learn more about private equity, the risks and rewards and how to invest to determine if this asset class is right for you.
What is private equity?
Private equity is an asset class and investment strategy that aims to acquire, or take an interest in, mature or growth-stage private companies.(1) PE investors hope that by investing in these companies, they will be able to sell their stake, or the entire company, later at a profit.
Private equity (PE) is often used interchangeably with terms like private equity firms, private equity investors and private equity funds. However, even though they are closely interconnected terms, they do not carry the same meaning. Private equity is an asset class that encompasses all these terms. Private equity firms invest in PE using pooled funds, or private equity funds.
How private equity works: The role of private equity firms
A private equity firm is an investment company that raises money to acquire a stake in private companies.(1) These pools of money are called private equity funds.(2)
Depending on the strategy, a PE firm can acquire a majority stake in a company for easier control and execution of the improvements or acquire a minority stake for more of an advisory role. Either way, the main goal of PE is to invest money into a private company, make it more profitable and sell it for a profit.
Private equity vs. venture capital
Venture capital (VC) is a form of private equity investment that targets startups and early-stage companies seeking funding. Venture capital and private equity both fall under the broader category of private markets, but they differ in their investment focus.
VC investors typically look for the next disruptive company that will revolutionize the industry. In exchange for providing capital, investors receive an ownership stake in the company through shares.(3) The time from initial investment to payout can be up to 10 years. PE typically invests in more established companies to improve their efficiency and profitability.
Traditionally, PE was only for accredited investors and private equity firms. However, private equity funds and crowdfunding platforms now allow retail investors to participate.
Private equity ETFs
Private equity ETFs such as the Invesco Global Listed Private Equity ETF (PSP) and ERShares Private-Public Crossover ETF (XOVR) are the simplest way to get exposure to private equity. These ETFs usually invest in publicly traded PE firms or in companies that themselves hold private equity portfolios. Either way, private equity ETFs give indirect exposure to PE.
Private equity funds
Unlike private equity ETFs, private equity funds offer direct exposure to PE by investing in high-growth, pre-IPO companies. While these funds are not yet mainstream for retail investors, accessibility is increasing.
Platforms such as Fundrise and SoFi Active Invest let you invest in PE through various funds and special purpose vehicles (SPVs), offering exposure to top private tech companies, including SpaceX, Databricks and OpenAI. Minimum investments range from $10 to $25,000, depending on the fund.
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Risks and rewards of private equity
PE offers the potential for high returns, but it comes with significant risks that investors must carefully consider. Unlike public market investments, PE involves long-term capital commitments, limited liquidity and active management involvement. Below is a breakdown of the key risks and rewards associated with private equity investments.
Risks
Private equity investments can be highly profitable but are not without challenges. Investors should be aware of the following risks:
Illiquidity. PE investments are long-term and often cannot be easily sold.
Success rate. Many PE investments involve turning around struggling businesses, which may not always succeed.
Long investment horizon. Investors may have to wait years before seeing any returns.
Lack of transparency. PE firms invest in private companies, which aren’t required to publicly disclose financial statements.
Rewards
Despite the risks, private equity remains an attractive investment option due to its potential for outsized returns and value creation. Key rewards include:
Higher return potential. Historically, PE investments have outperformed public markets.(4)
Active value creation. PE firms actively manage and improve businesses.
Access to exclusive deals. PE investors get exposure to private companies.
Diversification benefits. PE investments are less correlated to stock market fluctuations.
Growing retail investor access. Private equity ETFs and funds let retail investors participate in PE in a way that was traditionally limited to accredited investors.
Bottom line
Private equity offers a unique opportunity for investors seeking higher returns, but it also carries risks like illiquidity and high capital requirements. Whether you’re an accredited investor or exploring new entry points like crowdfunding and ETFs, understanding PE strategies is key to making informed decisions.
Frequently asked questions
Yes, but the regulations differ from those of public companies. Private equity firms generally register with the Securities and Exchange Commission (SEC) if they manage over $150 million in assets. However, they're not subject to the same disclosure requirements as public companies.(5) They must follow rules on fiduciary duties, reporting to investors and anti-fraud regulations, but financial details of their portfolio companies are usually kept private.
Private equity firms make money through management fees and carried interest.
Many private equity investments required accreditation. However, non-accredited investors can invest in private equity through private equity ETFs and funds.
Shane's career started with the US Department of Defense where he performed research for 8 years. He then studied philosophy and became fascinated by the ways in which technology and finance can consolidate to impact the world's socio-economic order. To date, he has written hundreds of articles with various insights into digital assets, trading, investing, and the ways in which technology can be used to further optimize the stock trading and settlement processes. His work has been featured in Yahoo Finance, Nasdaq, Bitcoin Magazine, Investing.com, Tokenist, and others.
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