What’s private equity? How do I get a part of the action?
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Simply put, “Private Equity” is an ownership position in a company that is not publically traded. It’s considered an “alternative investment” and in the past has not been easily accessible by individual investors. Just like any investment option, there are risks and opportunities to consider before jumping in.
While private equity has long been considered a cornerstone of alternative investments, it historically has been an asset class confined to large, institutional investors due to illiquidity constraints and large minimum investment requirements.
In its essence, investments in privately held companies offer an avenue for capital deployment with distinct advantages beyond traditional public markets due to its expanding opportunity set and benefits for portfolio diversification.
The Opportunity Set
One of the key attractions of private equity lies in the illiquidity premium it offers. This means that investors may expect to receive additional returns for the risk of investing in vehicles where access to the investment’s value is not readily available.
Unlike publicly traded assets, private equity investments are not subject to daily pricing, providing a strategic advantage of lower volatility since they are not subject to the whims of daily market price changes. This characteristic often translates into potentially higher and less volatile returns over time.
Moreover, private equity grants investors access to many companies that are unavailable in public markets. There are over 7 million private companies in the U.S., compared to less than 5,000 publicly traded companies. The number of publicly traded companies is shrinking, whereas private companies have increased by 3x over the last decade.
Furthermore, even the companies that ultimately transition from private to public tend to stay private for longer. This allows them to grow larger and provide greater returns as private companies.
Access
Another recent change to private markets involves investor access. Historically, private equity was primarily accessible to institutional investors and the ultra-wealthy. However, the landscape has evolved, and new investment instruments have decreased minimums and lowered investor qualifications.
This is enabling a broader spectrum of investors to participate in the space. Traditional private equity firms have a limited window to raise funds. Once capital is invested, the investor will be illiquid for several years until the fund is exited.
Tender Offer Fund structures allow for more liquidity, as investors can buy across multiple vintage years. These funds continuously offer shares at their computed NAV and allow shareholders to sell their shares back to the company or other investors.
Tender Offer Fund structures have allowed more investors to engage in private equity by providing immediate access to a portfolio of privately held companies that are diversified across vintage years, sectors, and geographic locations. While not all private equity investments align with these characteristics, the options are more readily available than in past years.
Another recently added benefit is simplified tax reporting. The ability to avoid complex K-1 tax forms for many private investments and the creation of standardized and electronic subscription documentation processes are a few ways the process has been simplified for individual investors.
Summary
Private equity presents an enticing proposition for investors seeking enhanced returns and diversification beyond traditional asset classes. With its illiquidity premium and access to a burgeoning pool of private companies, private equity offers a compelling long-term investment opportunity.
However, it’s crucial to recognize that private equity may not suit every investor. Before entering the space, risk tolerance, investment time horizon, and liquidity should all be considered.
Where appropriate, exposure to private equity is emerging as a long-term strategic investment that can create wealth and diversify a portfolio.
Collin Knecht is an Investment Analyst at Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.BedelFinancial.com or email Collin at CKnecht@BedelFinancial.com.