What is Private Equity? Is it Right for Me?

September 6, 2024

Private Equity (PE) has become an increasingly popular investment avenue for those seeking higher returns and a more active role in driving business growth. But what exactly is Private Equity, and how do you know if it’s the right fit for you or your organization?

At its core, Private Equity is a form of investment that involves pooling capital from investors to acquire stakes in private companies. These companies are typically not listed on public stock exchanges. The goal of a PE firm is to improve the performance of these companies and then eventually sell the stake for a profit. This process usually spans several years and requires strategic insight, industry expertise, and active management.

Let’s break it down further.

How Private Equity Works

When you invest in Private Equity, you’re investing in a fund managed by a PE firm. These funds often target established private companies with potential for growth or transformation. Unlike public markets, where the focus is often on short-term gains, PE investments are long-term commitments, typically lasting anywhere from five to ten years.

The PE firm takes a hands-on role in improving the business. This could involve enhancing operational efficiencies, guiding strategic decisions, or introducing new management. The idea is to create value that will be realized when the company is eventually sold or taken public through an IPO (Initial Public Offering).

Types of Private Equity Investments

Private Equity comes in many forms, each with its own risk-return profile and strategic focus:

  1. Venture Capital: Early-stage investments in startups or young companies with high growth potential.
  2. Growth Equity: Investments in more mature companies looking to expand or restructure operations.
  3. Buyouts: Acquisitions of controlling stakes in established companies, often with the goal of restructuring or optimizing the business for higher returns.
  4. Distressed Investing: Acquiring companies in financial trouble, with the intent of turning them around and selling them for a profit.

Each type of PE investment comes with varying degrees of risk and involvement, and it’s important to align these factors with your financial goals and risk tolerance.

Is Private Equity Right for You?

While Private Equity can offer significant upside, it isn’t suitable for every investor. Here are a few factors to consider before diving in:

  • Investment Horizon: PE investments are long-term commitments. Investors typically won’t see returns for several years, so if you need liquidity in the near future, PE may not be the right fit.
  • Risk Tolerance: The potential for higher returns in PE comes with higher risk. Unlike public markets, private companies are less transparent, and their valuation can be complex and subject to change based on operational performance and market conditions.
  • Capital Requirements: PE investments often require significant capital. The minimum investment for most PE funds can be much higher than traditional public market investments.

Benefits of Private Equity

Despite the risks and challenges, Private Equity can offer distinct advantages for the right investors:

  • Potential for Higher Returns: Historically, PE has outperformed public equities over the long term.
  • Portfolio Diversification: Adding PE to your portfolio can diversify your investments away from the public markets and provide exposure to different industries and company stages.
  • Control and Influence: With larger ownership stakes, PE investors often have greater control over business decisions, providing the opportunity to directly influence the company’s growth and value creation.

Conclusion

Private Equity is a powerful tool for investors seeking long-term growth and a more active role in driving business growth. However, it requires a deep understanding of the underlying investments and a commitment to the long-term success of the companies involved. If you’re considering adding Private Equity to your portfolio, it’s essential to assess whether it aligns with your financial goals, risk tolerance, and investment horizon.

At our firm, we work with institutional clients, including municipalities, endowments, foundations, and Alaska Native entities, helping them navigate the complexities of Private Equity. Our tailored investment strategies ensure that each client receives personalized advice that aligns with their goals and resources. If you’re new to Private Equity or considering making it part of your investment strategy, we’re here to guide you through the process.

Brandy Niclai, APCM CIO, Multi Asset Strategies