What is Private Equity?

I enjoyed the thought of this college football season returning much more than I’m enjoying the actual season. Like I knew the Florida Gators would be bad, but I wasn’t expecting them to be bad bad…

Private equity (often just referred to as PE) is an alternative investment in which investors can gain an ownership stake in private companies.

Instead of buying shares of publicly traded companies like Apple or Google, private equity investing allows investors to have their money invested in private companies like the donut shop down the street that takes all of my money.

Private equity generally involves three parties:

1. The investors who supply the money

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

3. The company that the private equity firm invests in

The investors

Private equity investing isn’t for casual retail investors, although it’d be a lot cooler if it was. The barrier to entry for those wanting to invest in private equity funds is extremely high. 

PE funds have high minimum investment requirements, ranging from $25,000 to $25 million. In addition, you’ll also need to be an accredited investor to invest in PE funds, meaning your net worth is over $1 million or your annual income was over $200,000 for the past two years.

Pocket change, honestly.

The private equity firm and the companies they invest in

Private equity firms put the money held in private equity funds to work.

They often do this through two common PE investments: buyouts and venture capital.

A buyout is when a PE firm buys an existing (often underperforming) company with the hopes of selling it later for a profit. It’s essentially the business version of house-flipping: PE firms buy a company with room for improvement, seek to improve its operations/management/profits, and then sell the improved company for a profit, making money for themselves and their investors (hopefully).

Although PE firms can buy out public companies, they tend to purchase private companies. If the company is public, it is usually taken private upon acquisition. PE firms don't want to answer to any shareholders.

Where buyouts aim to buy and sell mature companies, venture capital involves investing in promising start-ups looking to raise money in exchange for equity in the company.

The goal is to either sell the start-up at a later date for more money than they paid for it or take the company public through an initial public offering (IPO). After an IPO, a PE firm’s ownership stake in the company can be converted to an equivalent percentage of shares in the company’s stock.

Although both buyouts and venture capital carry risk, venture capital is generally a riskier option due to a lack of historical financial performance data in start-ups to justify an investment. The analysis required and risk associated with venture capital is why there is an entire subdivision of private equity that only does venture capital. They are called, shockingly, Venture Capital Firms.

The biggest private equity firms are Blackstone, Apollo, KKR & Co., and The Carlyle Group.

PE sounds like a cool field to work in, and it definitely can be, but it isn’t all sunshine and rainbows. In exchange for a LOT of money, PE firms (and really all other high finance jobs) are notorious for sucking the life out of their novice, MBA-holding employees.

Between outrageously long work hours, immense pressure to perform, and the competitive nature of PE, the rates of burnout, substance abuse, and mental health issues among high finance employees are high.

Playing chess instead of checkers, PE firms also own between 6-7% of mental health and addiction treatment facilities in the US. Contribute to the problem, monetize the solution. Big brain moves.

Why invest in PE?

The two main reasons why private equity is an attractive investment option are diversification and the potential for higher returns.

Private equity offers investors the opportunity to diversify their investment portfolio so the entirety of one’s portfolio isn’t tied to only publicly traded companies or real estate.

Many PE investors have also seen higher returns than that of the stock market over the past 20-25 years. In the 25-year period ending in June 2020, the US Private Equity Index saw an annualized return of 12.84% compared to the S&P 500's 8.78%.

The risks of PE

As with any investment, investing in private equity funds involves risk.

PE investing is often feast or famine. As an investor, you have little to no say in how the firm invests your money. They’re going to do what they see fit to get the best outcome. If PE firms invest in the right company, you’ll see big returns. If not, you won’t.

To gain diversification into a different asset class (private equity), you put your money in something that inherently lacks diversification by buying a single company.

Your money is far less liquid in a private equity fund than in the stock market. In the stock market, you can buy and sell securities whenever you want. Due to the necessity of guaranteed capital to invest in companies on their investors’ behalf, PE firms often require investors to keep their money in the private equity fund for as long as 10 years.

Private equity funds are also not regulated by the SEC, so there’s less official oversight to make sure PE firms aren’t doing anything weird.

Furthermore, private companies don’t have the public scrutiny and auditing emphasis that publicly-traded companies do, making the financial health of private companies more difficult to evaluate. With the magnitude of "accounting hocus pocus" seen in public companies, one can imagine that private companies seeking to be acquired aren’t above doing the same.

How to invest in PE

Step 1: Have a lot of money.

Step 2: Invest either directly into a PE fund with a PE firm or indirectly through a fund of funds, an ETF that tracks publicly traded PE firms, through crowdfunding, or other means.

Is private equity investing a requirement for meeting your retirement goals? Definitely not. But it’s another tool in your investing tool belt to use or not use as you see fit.

Call to Action

If you have money and are interested in dabbling in PE investing, do your due diligence before diving in.

What We’re Reading/Watching/Listening To:

I’m pretty sure I’ve shared this before, but Good Work's YouTube video on private equity is always a hit. It’s also a sad (and probably biased) look into the world of PE.

Debrief on Deck

Next week, Wilson will take on the Monthly Market Debrief for September. With Federal Reserve interest rate cuts (despite Wilson’s warnings) and Harris/Trump both throwing random economic policy spaghetti on the wall to see what sticks with voters, it’s been a fun month for finance.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

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