Investing in Private Equity Firms

With private equity investments earning nearly 12 percent in annualized returns from 2005 to 2015—nearly double the Standard & Poor’s 500 returns over those years—the popularity of private equity investments is growing [i]. 

The Private Equity Growth Capital Council found that private equity returns have outperformed public markets in recent years. The median private equity benchmark outperformed public markets on a 3-year, 5-year, and 10-year basis. Over a 10-year period, the median private equity benchmark achieved an 11.8 percent annualized return, almost double the S&P 500 returns of 6.8 percent.

When it comes to private equity investments, people are usually referring to private equity firms that invest large sums of money in privately held businesses. The private equity firms work with these companies, often over many years, to grow them and later sell at a substantial profit. The funds are often used to develop new products, make acquisitions and improve a company’s balance sheet. Private equity investors earn money when the performance of these companies improves.

How to Invest in the Private Equity Market

Wealthy individuals and institutional investors, including family offices, pension plans and university endowments, are some of the primary parties that invest in private equity. The funds go into pools for early stage, high-risk ventures, or into new companies with the potential for significant growth. These companies are often in industries such as healthcare, biotechnology, telecommunications, hardware and software. The goal of the private equity firm is to add value to the businesses they purchase by making them more profitable.

Investing in the world of private equity typically requires an investment of at least $250,000. While some firms permit minimum investments of $250,000, many are looking for investors willing to commit up to $25 million.

In most cases, private equity deals fall under a U.S. Securities and Exchange Commission regulation requiring investors to be “accredited,” meaning they must have income of more than $200,000 per year for the last two years, or $300,000 for married couples, and a reasonable expectation of continuing to earn the same amount or more over the next year. Alternatively, they can become “accredited” if they have a net worth, not including their home, of more than $1 million. 

Those seeking to invest in private equity should find a firm that specializes in this field. The partners at private equity firms raise money and oversee funds for shareholders. Private equity firms often have billions of dollars under their management, and most of these funds are used to direct investment in companies.

How Do Private Equity Investments Work?

Typically, investors will pool capital, which in turn will be invested into undervalued private companies with upside growth potential, or into public companies needing a revamp of their operations.

Private equity firms typically offer returns that are higher than other asset classes such as stocks, bonds and real estate. The higher returns are mostly the result of private equity firms investing funds in companies over a number of years. This gives management time to generate substantial profits. These companies often benefit from the expertise of the management executives who work to ensure the companies generate a profit. 

Usually, the private equity funds are structured as “limited partnerships” managed by general partners. The investors providing the capital to private equity funds are known as “limited partners.” General partners and limited partners maximize their returns by pooling capital. The private equity funds are usually invested in a number of businesses, helping to achieve a high rate of return for investors.

 

[i] http://www.investmentcouncil.org/private-equity-returns-far-exceed-declining-market-returns-on-multiple-time-horizons/

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