How to Invest in Private Money

Private equity (PE) refers to capital investment made into companies that are not publicly traded. Most PE firms are open to accredited investors or high-net-worth individuals, and successful PE managers can earn over a million dollars a year. Leveraged buyouts (LBOs) and venture capital (VC) investments are two key PE investment sub-fields.

Private Equity Fundamentals

Private equity is ownership or interest in an entity that is not publicly listed or traded. Private equity comes from firms that purchase stakes in private companies or acquire control of public companies with plans to take them private and delist them from stock exchanges. Private equity can also come from high-net-worth individuals (HNWI) who are eager to see outsized returns.

The private equity industry is comprised of institutional investors, such as pension funds, and large private equity firms funded by accredited investors. Because private equity entails direct investment, a significant capital outlay is required, which is why funds with deep pockets dominate the industry.

The minimum amount of capital required for accredited investors can vary depending on the firm and fund. Some funds have a $250,000 minimum entry requirement, while others can require millions more.

The underlying motivation for such commitments is the pursuit of achieving a positive return on investment (ROI). Partners at PE firms raise funds and manage the money to yield favorable returns for shareholders, typically with an investment horizon of between four and seven years.

Why Private Equity Firms Are Important

Private equity firms play a crucial role in the investment landscape. They provide capital to companies that may not have access to traditional sources of funding, such as public markets. By investing in these companies, private equity firms can help fuel their growth and expansion.

Additionally, private equity firms often take an active role in the management and operations of the companies they invest in. They bring expertise, resources, and strategic guidance to help these companies reach their full potential. This hands-on approach can lead to significant value creation and ultimately generate attractive returns for investors.

Private equity firms also contribute to job creation and economic growth. By investing in small and mid-sized companies, they can help these businesses expand their operations, hire more employees, and contribute to local economies.

Types of PE Firms

Private equity firms have a range of investment preferences. Some are strict financiers or passive investors wholly dependent on management to grow the company and generate returns. Other PE firms consider themselves active investors and provide operational support to management to help build and grow a better company.

Active private equity firms may have an extensive contact list and C-level relationships within a given industry, which can help increase revenue. They might also be experts in realizing operational efficiencies and synergies. If an investor can bring something special to a deal that will enhance the company’s value over time, they are more likely to be viewed favorably by sellers.

Investment banks compete with some private equity firms to buy good companies and finance nascent ones. For instance, the Blackstone Group, which has been involved in the buyouts of companies such as Hilton Hotels and MagicLab, trades on the New York Stock Exchange.

How PE Firms Create Value

Private equity firms perform two critical functions: deal origination and transaction execution, and portfolio oversight and management.

Deal Origination and Execution

Deal origination involves creating, maintaining, and developing relationships with mergers and acquisitions intermediaries, investment banks, and similar transaction professionals. These relationships secure both high-quantity and high-quality deal flow, referring prospective acquisition candidates to private equity professionals for investment review.

Transaction execution involves assessing management, the industry, historical financials and forecasts, and conducting valuation analyses. After the investment committee signs off on pursuing a target acquisition candidate, the deal professionals submit an offer to the seller. If both parties decide to move forward, the deal professionals work with various transaction advisors to execute the due diligence phase.

Portfolio Oversight and Management

Oversight and management make up the second important function of private equity professionals. Among other support work, they can walk a young company’s executive staff through best practices in strategic planning and financial management. Additionally, they can help institutionalize new accounting, procurement, and IT systems to increase the value of their investment.

Private equity firms also create value by increasing operational efficiencies and aligning the interests of company management with those of the firm and its investors. By taking public companies private, private equity firms remove the constant public scrutiny of quarterly earnings and reporting requirements, allowing them and the acquired firm’s management to take a longer-term approach to improve the company’s fortunes.

Private Equity Investment Strategies

Two common private equity investment strategies are leveraged buyouts (LBOs) and venture capital (VC) investments.

Leveraged Buyouts (LBOs)

LBOs involve a private equity firm buying out a company and financing the purchase through debt, which is collateralized by the target’s operations and assets. The goal is to maximize potential returns by leveraging the investment.

Venture Capital (VC)

VC involves taking an equity investment in a young company in a less mature industry. Private equity firms often invest in companies with potential but are held back by a lack of revenues, cash flow, and debt financing. By guiding the target’s management and providing resources, PE firms can add value to the company and help it grow.

How PE Firms Exit a Deal

One popular exit strategy for private equity firms involves growing and improving a middle-market company and selling it to a large corporation. Private equity firms can identify small companies with niche products or services that are not offered by large conglomerates. By improving the company’s operations and increasing its value, private equity firms can generate a profitable exit strategy through resale, an initial public offering (IPO), or an alternative option.

How to Invest in Private Equity

Private equity opportunities are often out of reach for individuals who can’t invest millions of dollars. However, there are some ways for smaller investors to access the private equity market.

• Publicly Traded Stock: Some private equity investment firms offer publicly traded stock, allowing average investors to own a slice of the PE market.
• Funds of Funds: Mutual funds can invest indirectly in private equity by buying shares of publicly-listed private equity companies.
• Exchange-Traded Funds: Investors can purchase units in ETFs that hold shares of private equity firms.
• Crowdfunding: Private equity crowdfunding allows individuals to invest in companies in exchange for partial ownership. Online platforms facilitate these investments.

Working at a Private Equity Firm

Private equity firms attract top talent from corporate America, consulting firms, and law firms. The industry offers high compensation and opportunities to work on high-profile deals. A career in private equity often requires prior related work experience in investment banking or consulting.

How Do Private Equity Owners Make Money?

Private equity owners make money by buying companies they believe have value and can be improved. They improve the company, which generates more profits. They also make money when they eventually sell the improved company for more than they bought it for.

Why Is Private Equity So Hard to Get Into?

Finding a job in private equity is hard because it is a competitive industry with limited job opportunities. Private equity firms seek out the best candidates and often require prior related work experience in investment banking or consulting.

What Is the Disadvantage of Private Equity?

Private equity comes with disadvantages, including increased risk, difficulty acquiring and growing a business, lack of liquidity, and high fees. Once invested in a private equity transaction, it can be challenging to exit or sell the investment.

In conclusion, private equity offers opportunities for investors to invest in companies that are not publicly traded. By providing capital and expertise, private equity firms can help these companies grow and generate attractive returns. While private equity opportunities are often limited to accredited investors, there are ways for smaller investors to access the private equity market. Working at a private equity firm can offer a rewarding career for top talent in the finance and consulting industries.