Private Equity Investing: What It Is and How You Can Invest - NerdWallet (2024)

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A private equity fund is a pooled investment offered by a private equity firm that allows a group of investors to combine their assets to invest, typically in a company or business.

Private equity is a way for accredited investors and institutional investment firms to diversify their portfolios and take on more risk in exchange for the potential to earn higher returns than they might by investing in public companies.

At a basic level, private equity involves three parties:

  1. The investors who supply the capital.

  2. The private equity firm that manages and invests that money via a private equity fund.

  3. The companies the private equity firm invests in.

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Who can invest in private equity?

Traditional private equity funds have very high minimum investment requirements, potentially ranging from a few hundred thousand to several million dollars. As such, most private equity investing is reserved for institutional investors (such as pension funds or private equity firms) or high-net-worth individuals.

In addition to meeting the minimum investment requirements of private equity funds, you’ll also need to be an accredited investor, meaning your net worth — alone or combined with a spouse — is over $1 million or your annual income was higher than $200,000 in each of the last two years.

How private equity investing works

Let’s say you invest $1 million through a private equity firm (traditional private equity funds typically have very high minimum investments). The private equity firm would put your money in a private equity fund along with money from other investors and invest the pool of money in various private equity instruments, such as buyouts or venture capital (more on those below).

» Looking for accredited investor opportunities? Learn how to become an angel investor

Why invest in private equity?

Investors turn to private equity to diversify their holdings and aim for higher returns than the public market might provide. One key distinction to consider before investing is that private equity valuations are not influenced by the larger market. Whereas publicly traded companies must adhere to strict accounting practices set in place by the Securities and Exchange Commission, private companies are allowed more flexibility. So, while private equity funds certainly come with higher risk, historically, they have resulted in higher returns. According to the Bain & Company Global Private Equity Report 2023, private market returns have outpaced public market returns over every time horizon.

Limited partnerships

When you invest in a private equity fund, you can think of yourself as a secondary investor, or in official terms, a limited partner. You supplied the capital that helped make the investment possible, but you won’t be responsible for managing the newly purchased company, making any of the necessary improvements or handling the eventual sale or public offering. That’s what the firm does.

Limited partners get a return on their investment when the private equity firm sells the company it purchases. Typically, the firm will take about 20% of the profits, and the rest is split among the limited partners based on how much they contributed to the fund. Moreover, limited partners have limited liability, meaning the maximum they can lose is the amount they invested in the fund.

» Is private equity right for you? Working with a wealth advisor may help you decide

How to get started investing in private equity

Research top private equity firms

To directly invest in private equity, you’ll need to work with a private equity firm. These firms will have their own investment minimums, areas of expertise, fundraising schedules and exit strategies, so you’ll need to do your research to find one that’s right for you. As a starting point, here are the 10 largest private equity firms in the world, based on how much capital they raised in the last five years. This list is compiled annually by Private Equity International, a global provider of private equity data and analysis.

  1. KKR

  2. Blackstone

  3. EQT

  4. CVC Capital Partners

  5. Thoma Bravo

  6. The Carlyle Group

  7. General Atlantic

  8. Clearlake Capital Group

  9. Hellman & Friedman

  10. Insight Partners

Look for private equity exchange-traded funds

You can also take part in private equity investments without going through a traditional firm through private equity exchange-traded funds, or ETFs.

Private equity ETFs offer exposure to publicly listed private equity companies. This is one approach for those who want to take part in private equity but aren’t accredited investors or can’t meet the minimums required by private equity funds. By investing in ETFs that track these companies, their success is also yours, and you won’t have to front a hefty minimum investment to get in on it.

Types of private equity investments

Once you contribute to a private equity fund, the private equity firm can use your contribution in a few different ways to generate profit, depending on the types of deals the firm specializes in. Below are two common private equity investments.

Buyouts

A buyout is when a private equity firm buys a target company with the hope of selling it later at a profit. That company can be public or private, though if it’s public, it will be taken private through the purchase. Often, private equity firms use capital from the fund as well as borrowed money to complete the deal, using the assets of the company being purchased to secure the loan. When borrowed money is involved, the deal is known as a leveraged buyout.

In a buyout, the private equity firm might identify a company with room for improvement, buy it, make improvements to its operations or management (or help the company grow), then turn around and sell the company for a profit, known as an “exit.” In many ways, it’s similar to flipping a house — just replace the house with a company.

Venture capital

Whereas buyouts seek to take control of mature companies, venture capital involves identifying early-stage startups looking to raise cash in exchange for equity in the company. The goal here is to invest in companies with high growth potential that can either be sold at a later date or taken public through an initial public offering, or IPO. After an IPO, the firm’s ownership stake could be converted to shares and sold on the public market for a profit.

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Risks of private equity

Illiquidity

As a limited partner, to see a return on your private equity investment you’ll likely need to hold it in a private equity fund for the long term, often as long as 10 years. Private equity funds work differently than more common fund types (such as mutual funds) in that limited partners typically must commit a set amount of money that the firm can use as needed within a specified period. When the firm requests an investment amount from its investors, it’s known as a capital call.

For example, a private equity firm may make various investments over a five-year period, calling on its limited partners for capital during that time. Then, once the firm has identified investments in target companies and raised the needed capital, it still needs to make improvements to the companies or spur growth before selling them.

Compared with other types of investments that can be easily converted into cash, like stocks, the combination of capital call investment periods and the time it takes to sell a target company makes private equity highly illiquid.

Transparency, regulation and data

Private equity funds aren't registered with the Securities and Exchange Commission, so private equity firms aren’t required to publicly disclose information about their funds (unlike, say, a mutual fund, which is subject to public disclosure requirements).

Moreover, privately held companies — often the targets of private-equity acquisitions — aren’t subject to public scrutiny. It’s up to the private equity firm to identify companies with healthy, complete and accurate balance sheets. This leads to varying risk levels within the private equity universe: Mature companies in a buyout may provide transparency on years of earnings and operations data, while an early-stage startup has very little of this information. This makes investing in an unproven startup through venture capital inherently more risky than investing in a growth-stage company with established revenue and market share.

» High risk tolerance? Learn more about alternative assets

Private Equity Investing: What It Is and How You Can Invest - NerdWallet (2024)

FAQs

What is private equity and how to invest? ›

Private equity strategies generally involve investing in companies that are not publicly traded on stock exchanges. Private equity fund managers (also known as general partners or GPs) often seek to generate returns by enhancing the performance of their portfolio companies over the course of their holding period.

How much money do I need to invest to make $3,000 a month? ›

Imagine you wish to amass $3000 monthly from your investments, amounting to $36,000 annually. If you park your funds in a savings account offering a 2% annual interest rate, you'd need to inject roughly $1.8 million into the account.

What can you say about private equity investing? ›

Private equity investing is done in private companies, which are not listed on public exchanges like the companies you can invest in via the stock market. While it has the potential for high returns, it also comes with risk.

How risky is investing in private equity? ›

Private investments involve a number of risks, including illiquidity, lower transparency and less regulatory oversight than is found in public securities. They are also frequently early-stage or involve untested business models and management teams.

What is private equity for dummies? ›

Private equity (PE) describes investments that represent an equity interest in a privately held company. Any business that is not a public company is part of the substantial private company universe, which includes millions of US businesses compared with the few thousand that are public companies.

What is private equity in layman's terms? ›

Private equity describes investment partnerships that buy and manage companies before selling them. Private equity firms operate these investment funds on behalf of institutional and accredited investors.

How much money a month to make $100,000 a year? ›

$100,000 a year is how much a month? If you make $100,000 a year, your monthly salary would be $8,333.87.

How much do I need to invest to make $1000000? ›

Suppose you're starting from scratch and have no savings. You'd need to invest around $13,000 per month to save a million dollars in five years, assuming a 7% annual rate of return and 3% inflation rate. For a rate of return of 5%, you'd need to save around $14,700 per month.

What is the average return on private equity funds? ›

This is why many investors expect the return for private equity to be higher than that for venture capital. However, this is not a rule that holds true for all years. According toCambridge Associates' U.S. Private Equity Index, PE had an average annual return of 14.65% in the 20 years ended December 31,2021.

What are the cons of private equity? ›

What are the cons of private equity investing? Private equity investments are illiquid: Investor's funds are locked for a certain period. As such, investors in private equity must have a long-term investment horizon and be willing to hold their investments for a few years, if not more.

Is investing in private equity worth it? ›

Private equity is an attractive investment option for high-net-worth individuals and institutional investors because of its potential for high returns. Private equity falls under the category of alternative asset classes.

Can normal people invest in private equity? ›

There are several ways to branch into private equity investing, including through mutual funds, exchange-traded funds, SPACs, and crowdfunding. However, keep in mind that many private equity opportunities are only offered to qualified investors and may require a sizable minimum commitment as well as a high net worth.

Why does private equity have a bad reputation? ›

They are often seen as ruthless cost-cutters who gut companies and lay off workers in order to make a quick profit. And while it is true that some private equity firms do engage in these practices, it is important to remember that not all private equity firms are evil.

Why can only rich people invest in hedge funds? ›

Because they are not as regulated as mutual funds or traditional financial advisors, hedge funds are only accessible to sophisticated investors.

How much money do I need to invest in private equity? ›

The minimum investment in private equity funds is typically $25 million, although it sometimes can be as low as $250,000. Investors should plan to hold their private equity investment for at least 10 years.

How do you make money in private equity? ›

Private equity owners make money by buying companies they think have value and can be improved. They improve the company or break it up and sell its parts, which can generate even more profits.

How do I start private equity? ›

Coming into private equity with no experience is impossible, so finding an internship or having previous experience in a related field is highly recommended. Private equity professionals can advance fast within a firm and typically start as junior associates or analysts.

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