7 Things You Need to Know Before Investing in Private Equity

Private equity (PE) might sound like something reserved for billionaires and boardrooms, but it’s increasingly becoming part of mainstream investment conversations. If you are looking to go beyond the stock market and want to explore alternative investments with the potential for higher returns, private equity might catch your eye. Before you jump in, it’s important to know what you are getting into. Discussed below are seven things you need to know about private equity. 

1. Understanding what private equity is

Private equity involves investing directly in private companies (those not listed on public stock exchanges) or buying out public companies to take them private. These investments are typically managed by PE firms that use a mix of investor money and borrowed funds to acquire businesses, grow them, and then sell them for a profit.

2. Different types of private equity investment

Private equity isn’t a universal investment. It includes various subcategories:

• Venture capital (VC): Investing in early-stage startups with high growth potential via pre-IPO investing platforms like hiive.com
• Growth equity: Capital for mature companies looking to expand or restructure operations
• Buyouts or leveraged buyouts (LBOs): Acquiring a company using a significant amount of borrowed money
• Distressed investments: Buying underperforming companies with the intent to turn them around

3. Long-term commitment is required

Unlike stocks that you can sell with a few clicks, private equity investments are illiquid. That means your money is typically locked up for seven to 10 years. It’s a long-term play, and not something to jump into if you might need that money soon.

4. Access is limited, and minimums are high

Private equity used to be off-limits unless you were a large institution or an ultra-wealthy individual. While things are starting to open up, thanks to new fund structures, most opportunities still require high minimum investments, usually starting from $250,000. 

5. Due diligence is critical

PE funds are less regulated and less transparent than public investments. You won’t find earnings reports or analyst coverage. Before you invest, dig deep. Who are the fund managers? What’s their track record? Have they succeeded in similar deals before? You also need to: 

• Understand the fund’s strategy
• Know the background of the managers
• Look at past performance
• Understand where your money will be invested

6. Fees can be high

Private equity investments often come with a “2 and 20” fee structure: A 2% annual management fee and 20% of profits (carried interest). While these fees can be justified by performance, they can also eat into returns, especially in less successful investments. It’s essential to understand the total cost of investing and how it impacts net returns.

7. Returns can be high, but so can risks

Private equity has a reputation for delivering above-average returns, especially in top-performing funds. However, it’s also riskier. Companies can fail, market conditions change, and exits may not go as planned. Diversifying across multiple PE funds can help manage this risk.

Endnote

Private equity is not for every investor. It requires time, trust, and tolerance for risk. It can be a powerful wealth-building tool, but only if you understand how it works and whether it fits your goals. Before investing, make sure you are comfortable with the risks, understand the structure, and that you believe in the fund manager.