How to Invest in Private Equity: A Step-by-Step Guide

Investing in private equity has many benefits. It’s a way to add diversity to your investment portfolio, which allows savvy investors unique opportunities to increase their wealth and offers higher returns because it’s an investment made away from the stock market or publicly traded entities.

If you’re new to private equity investing, you probably want to know how to get started after learning a few essential details about private investing and your options. Please keep reading and I’ll provide more information and get started with this exciting opportunity.

What is Private Equity?

Private equity is investments through private equity firms like start-ups and venture capital. Concerning investment opportunities, public and private markets are quite different, and learning more about these differences helps outline the value of private equity investment. I feel it’s essential to understand this structure before moving forward. 

Private equity is shares or stakes you purchase in a private company that isn’t publicly traded. It’s classified as an alternative asset class. Public equity, or shares of stock in a publicly traded company, is classified as a main asset class. 

A primary difference between these two options is how the equity fund is structured compared to publicly traded companies. A private equity fund is created when a limited partnership is formed. The partners or participants of the private equity firm include the following.

• Private equity firm
• Fund managers and management team
• Limited partners or investors

These key players form the private equity fund or limited partnership. The equity fund is then offered for portions of the investment.

Individuals are invited to contribute funds to the private equity fund. However, I’ll let you know that there are few investors receiving those invitations to invest. These investments are used for other investments and purchases that match an outlined investment strategy designed to create growth.

When an individual chooses to participate by providing funds to the private equity fund, that investor is considered a limited partner. The general partner is the private equity firm itself and is in control of the investment management processes.

About Private Equity Investments

There are characteristics of private equity in both the company and fund perspectives. Regarding the company’s structure and outlook, securing funding through alternative options is usually the best option.

If the company chooses to secure loans, they usually have a higher interest rate, which is not financially lucrative. In contrast, if the company were to trade publicly, there would be hesitation to invest initially, which places the company in a precarious situation in terms of financial assets. 

The best option for the firm is to put a call out to investors to pool their capital together to help the company invest in opportunities. The investors then get returns on their investment that can sometimes be much higher than investments in publicly traded companies.

Is private equity a good investment? 

In terms of the fund, I’ll be the first to tell anyone that there’s a higher risk, but there is also the potential for a higher reward. The private equity funds operate in the private markets, which feature new companies that don’t face the strict reporting and testing requirements that the publicly traded companies are subjected to before being offered. 

It’s up to the private equity firms to participate in their own due diligence to mitigate risk and give investors a clear overview of the potential of private equity investments. A primary goal of private equity investments is to create additional value to help increase the value of their stake in the company. 

The intention is to sell that stake in the company, so fund managers want to make it as valuable as possible. Intense planning and strategy are involved to ensure the company’s value is high when they are ready to sell. Internal teams are devoted to this strategy before the private equity fund is even invested in the company’s share.

The term leveraged buyout describes the private equity investment industry because they use debt to leverage the transaction. Hence, the private equity firm buys investments minimally priced and increases their profits if the shares sell at a gain.

This is where the risk is identified, however. If there is a loss, the losses can be more extreme than those in the publicly traded company markets. This is why I advise caution in any investment, especially in private equity. 

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Raising Funds for Private Equity

There are asset subclasses that make up global private equity fundraising strategies. These asset classes are known as the following.

• Venture capital
• Buyout
• Growth
• Additional Private Equity

The most abundant of the asset classes for funds is in venture capital. The venture capital fund invests in a private company early on in the company’s existence and for a much smaller amount. The middle areas consist of growth, and then finally, the buyout stage, which is the largest portion of the private equity money market.

Who Are Investors in Private Equity?

The most common investors for private equity include pension funds, mutual funds, university endowments, trusts, institutional investors, and high net-worth individuals.

It’s worth noting that individual accredited investors must meet strict Securities and Exchange Commission (SEC) guidelines to participate. These individuals must possess at least $1 million in funds and earn $200,000 annually if it’s a single investor and $300,000 annually if the investor has a spouse. 

There’s more to gaining the ability to invest, however. It depends on several factors, including the type of investment and what the individual’s outlined approach is to the investment in question. If a person is not a high-net-worth investor, there is another way to invest. It is possible to do private equity investing through ETFs too.

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How to Start Private Equity Investing

Ensure You Qualify

The first step is to qualify to invest in private equity funds. The most effective method of private equity investing is direct investment. As discussed previously, a person must be an accredited investor and meet the outlined SEC guidelines to participate.

Evaluate the Different Investment Strategies & Private Equity Firms’

This step is probably the most important one so take your time to determine which investments are a good fit for your goals and abilities. This process is much like investing in other funds. Some considerations for investing can include current investment interests, previous investments, risk tolerance, and the fund’s options.

Investing in private companies can range from focusing on growth companies to traditional debt financing for long-tenured, family-run businesses.

In today’s age, the private equity universe is massive. There is no one size fits all approach. Private equity firms come in all shapes and sizes so you need to find one that fits your needs.

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Consider a Diversified Portfolio

If an investor chooses to pursue direct investment in private equity, they create a portfolio for the investment that will earn returns according to the fund’s performance in accordance with the performance of the fund’s outlined investments. The earnings are generated based on a percentage of the returns in relation to the amount of the investment.

Directly investing in private equity has the potential to generate much higher returns than small, retail investors. A private equity fund almost always invests directly in a company. One instance where this might not be the absolute rule is in cases where acquisition is the target. 

In this case, the fund may purchase publicly traded shares of the company to complete the strategy. Before deciding this is the route to take to begin investing, consider that most private equity works at a large scope and, therefore, requires a large initial investment. I advise investors to have plenty of capital to invest to the tune of over $10 without missing it much. 

This large investment might be too large and risky starting out. For example, it’s commonplace for a private equity firm to ask for an initial investment of anywhere between $10 million and $25 million. That would require you to have a very high-risk tolerance and considerable private wealth.

Those who become accredited investors and have the capital on hand to invest in a private equity fund can move on to the part to contact a firm that matches those investment interests.

It’s also a great idea to team up with a broker or a financial advisor before moving forward with the investment. They can provide a wealth of insight into good investment options and can counsel on risk and attaining personal goals through this investment.

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A Simplified Step-by-Step Breakdown of Direct Investing in Private Equity

Follow these steps to begin the process of direct investing in private equity firms and funds. 

• Determine personal investment interests and goals
• Meet the SEC requirements to become an accredited investor ($1 million in assets, and earn $200,000-$300,000 annually)
• Ensure there are funds to invest in private equity. (Usually a minimum of $10 million dollars)
• Acquire the services of a broker to ensure goals and interests align with the right private equity firms and funds
• Contact the private equity firm to discover investment opportunities

Once they decide to invest with a private equity firm, they will outline the next steps for transferring funds to the investment and then generate a portfolio. Some online private equity investment firms operating today include YieldStreet, Artivest, Moonfare, Equi, and many others.

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Investing through ETFs and Other Platforms

Consider the following information regarding exchange-traded funds and how they work. Use those details to guide the investment strategy. 

Investing Through Private Equity ETFs

Most people wanting to start with private equity investing won’t qualify to become accredited investors capable of direct investing. That’s where exchange-traded funds come into play. The goal of ETFs is to build a diversified portfolio of funds offered by private equity firms or in the private equity firms themselves. These entities can invest in a few different ways. 

ETFs may choose to invest in companies that also invest in a private equity firm. In contrast, they may also invest in companies backed or funded by a specific private equity firm.

Of course, the most apparent investment strategy would be to invest directly in a private equity firm without investing in a different investment or investor company. This allows for more opportunities to gain capital and returns.

These entities allow individual investors to gain access to the market without the criteria and high initial investment required from direct investment options. On the downside of this option, investors can’t achieve the higher returns they would see if they invested directly. However, it’s still a foothold in the market that can open up more opportunities to invest further at a smaller magnitude. 

Investing in Special Acquisition Companies

Special Acquisition Companies, or SPACs, are shell companies that are publicly traded. This method for approaching private equity investing is risky. This is due to the fact that this type of company may only invest in a single company.

That means the investor receives low dividends or returns. They may have also committed to making certain investments by a date provided in their IPO and feel forced to make a risky investment during their research.

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Investing Through Crowdfunding

The most recent angle for investing in private equity is through crowdfunding. This strategy is most common for new companies or ventures. It works because each investor contributes a small amount to create a larger investment.

This method of investing is as risky as SPACs, but there are more options to invest. An important point to note is that you can invest as a donor or as an investor. If you want returns, you must do so as an investor./

Commonly Asked Questions

Consider these FAQs related to private equity investments. This information can provide insight into the world of private equity investment options and how they operate. 

Can a normal person invest in private equity? 

The average person has several avenues to consider if they want to invest in private equity. They can range from private equity ETFs to crowdfunding.

However, each option has its own risks and rewards. Getting sound advice or guidance from a financial investment broker or advisor can help investors decide which methods work best for their goals. 

What are the average returns on private equity funds? 

The average return for private equity investments is 11.0% over a 21-year period. In contrast, the average return for public stock investments is 6.9%. This figure makes it easy to see why investing in private equity funds is a good idea if they match investor interests, goals, and risk tolerance. 

If investors need to know if private equity investments are suitable, it’s a good idea to consult your investment broker or advisor. They can provide helpful insight and guidance to minimize risk while providing diverse options to add to your portfolio. I highly suggest taking this route to avoid lessons learned the hard way. 

Can retail investors invest in private equity?

Retail investors can technically invest in private equity funds, but it is challenging. This is because the initial investment is so high. As mentioned, the typical investment starts at $10 million and can go up.

The top private equity investments are usually heavily invested in already, and new investors are scrutinized. Typically, managers work with investors they know. 

How do PE investors get paid?

The private equity firm pays investors through dividends. This process works just like receiving earnings from public companies.

There is a process called dividend recapitalization that raises additional debt to pay the private equity investors. This approach allows the private equity firm to pay investors and keep their interest in the fund without having to sell shares to pay the investors.

The dividends are usually paid as cash or as stock shares. The payments can be set up at various intervals, such as monthly or quarterly.

Less frequent dividends are paid biannually or annually. There may also be a special dividend frequency that the private equity firm’s managers determine. 

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What do private equity investors look for in an opportunity?

Generally speaking, private equity firms invest in private companies either through a controlling or minority-interest equity or debt investment to generate a positive return on their invested capital for their limited partners.

The investor wants to see a clear path for potential growth over the next several years with profits to make it worth their time. Adequate research is necessary to uncover growth projections and trends before investing. If the projections look good for the next few years, investors are more likely to consider the opportunity. 

Summary

Many opportunities lie in private investment funds. Private equity investments are much like publicly traded stock investments in some ways, but the returns can be much higher, especially for a direct investor. Most investors won’t qualify to become accredited investors or direct investors, but there are other options for the average person looking to get started in the private equity investment realm. 

There are several avenues to consider when you’re getting started in private equity investing. Determining which avenues suit an investor’s situation can depend on their overall goals, available capital, risk tolerance, and interests.

Each method has its unique way of generating returns with smaller investment amounts. Working with a qualified investment professional can help individuals learn more and choose the best direction for their needs. 

Over time, I feel investors become more familiar with private equity investments, and branch out in different directions to create more opportunities to generate dividends at potentially higher than public companies. 

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