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Key Takeaways
- Private equity often involves early-stage, high-risk ventures in software and healthcare.
- Minimum private equity investments typically start at $25 million, sometimes as low as $250,000.
- Investors should plan to hold private equity investments for at least 10 years.
- Indirect private equity investments include funds of funds, ETFs, and SPACs.
- Private equity investing is speculative and very risky with no guarantee of success.
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Private equity is capital made available to private companies or investors. The funds raised might be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company’s balance sheet. Unless you are willing to put up quite a bit of cash, your choices in investing in the high-stakes world of private equity are minimal.
Why Invest in Private Equity?
Institutional investors and wealthy individuals are often attracted to private equity investments. This includes large university endowments, pension plans, and family offices. Their money becomes funding for early-stage, high-risk ventures and plays a major economic role.
Often, the money will go into new companies believed to have significant growth possibilities in industries such as telecommunications, software, hardware, healthcare, and biotechnology. Private equity firms try to add value to the companies they buy and make them even more profitable. For example, they might bring in a new management team, add complementary companies, aggressively cut costs, or spin off underperforming parts of the business.
Fast Fact
To learn more about investing in private markets (and advising clients interested in doing so), see the rest of the series: Private Market Edge.
Minimum Investment Requirements
Private equity investing is not easily accessible for the average investor. Most private equity firms seek investors willing to commit as much as $25 million. Although some firms have dropped their minimums to $250,000 (or even $25,000), this is still out of reach for most people.
Ways to Invest in Private Equity
There are a few indirect ways to invest in private equity.
Fund of Funds
A fund of funds holds the shares of many private partnerships that invest in private equities. It provides a way for firms to increase cost-effectiveness and reduce their minimum investment requirement. This can also mean greater diversification since a fund of funds might invest in hundreds of companies representing many different phases of venture capital and industry sectors. In addition, because of its size and diversification, a fund of funds has the potential to offer less risk than you might experience with an individual private equity investment.
Mutual funds have restrictions in terms of buying private equity directly due to the SEC’s rules regarding illiquid securities holdings. The SEC guidelines for mutual funds allow up to 15% allocation to illiquid securities. Also, mutual funds have their own rules restricting investment in illiquid equity and debt securities. For this reason, mutual funds that invest in private equity are typically the fund-of-funds type.
Important
The disadvantage is that there is an additional layer of fees paid to the fund or the fund’s manager. Minimum investments can be in the $100,000 to $250,000 range, and the manager may not let you participate unless you have a net worth between $1 million to $5 million.
Private Equity ETF
You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companies investing in private equities. Since you are buying individual shares over the stock exchange, you don’t have to worry about minimum investment requirements.
However, like a fund of funds, an ETF will add an extra layer of management expenses you might not encounter with a direct, private equity investment. Also, depending on your brokerage, each time you buy or sell shares, you might have to pay a brokerage fee or commission.
Special Purpose Acquisition Companies (SPACs)
You can also invest in publicly traded shell companies that make private-equity investments in undervalued private companies, but they can be risky. The problem is that the SPAC might only invest in one company, which won’t provide much diversification. As outlined in their IPO statement, they may also be under pressure to meet an investment deadline. This could make them take on an investment without doing their due diligence.
Crowdfunding
A recent development in private equity is the use of crowdfunding to raise capital, especially for new ventures, from individual investors, each contributing a relatively small amount. Today, several platforms offer a range of investment opportunities—but note that these investments can be highly risky.
Tip
If you participate in equity crowdfunding, make sure you do so as an investor and not as a donor (as in the case of Kickstarter-like crowdfunding platforms). Donating doesn’t imply a hope for return, but investing does.
How Much Money Do You Need to Invest in Private Equity?
Although you may be able to find a private investment opportunity that requires as little as $25,000, a common private equity investment minimum is $25 million. However, there are some indirect ways to invest in private equity for much less, such as buying a share of a private-equity ETF.
How Do I Get Into 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 and high net worth.
How Risky Is Investing in Private Equity?
Private equity investing can be very speculative and therefore very risky. There is no guarantee that the companies you invest in will succeed, and there are few protections for you if they fail.
The Bottom Line
There are several key risks in any private equity investing. As mentioned earlier, the fees of private-equity investments that cater to smaller investors can be higher than you would normally expect with conventional investments, such as mutual funds. This could reduce returns. Additionally, more people investing in private equity means more competition for the same deals, which can make it harder for firms to find the best opportunities, and thus lower the returns for everyone involved.
Plus, some of the private equity investment vehicles that have lower minimum investment requirements do not have long histories for you to compare to other investments. You should also be prepared to commit your money for at least 10 years; otherwise, you may lose out as companies emerge from the acquisition phase, become profitable, and are eventually sold.
Companies that specialize in specific industries can carry additional risks. For instance, many firms invest only in high-technology companies. Their risks can include:
- Technology risk: Will the technology work?
- Market risk: Will a new market develop for this technology?
- Company risk: Can management develop a successful strategy?
Despite its drawbacks, the potential payoff of investing in private equity could be big if you are willing to take a little more risk with 2% to 5% of your investment portfolio.
