Most investments fall into one of the traditional buckets: stocks, bonds, mutual funds, insurance products, real estate, or crypto.
And while you can certainly build wealth using any of these avenues, their upside typically has some sort of cap. With private equity investing, there is a good potential for upside.
Yes, it comes with risk, but if you know what you’re doing, private equity investments can become the most important levers in your portfolio.
Contents
What is Private Equity?
You could describe private equity as a type of financing where individuals or firms invest capital into a business that operates in a traditional field in exchange for an ownership stake and/or contractual rights to a percentage of revenue or profits.
Technically speaking, private equity is labeled as an “alternative” investment. This simply means it’s not a traditional investment you make on Wall Street. It slots into the same overarching category of investments like venture capital, real estate, hedge funds, etc.
Typically, private equity firms use the capital from investors to purchase a controlling stake (50 percent or more) in the company and then make improvements to create growth and increase profitability.
How Private Equity Investments Generate ROI
So I know what you’re thinking – sounds great (and kinda vague) but how does private equity actually generate a return on investment? The answer depends on the type of investment and how it’s structured. Here are a couple of basic ways:
- LBOs. Leveraged buyouts, also known as LBOs, are probably the most common way private equity firms create returns for their investors. This approach involves optimizing the way the capital investment is structured to create value for the investors. There are four main ways this happens, including through a repackaging plan, split-up plan, portfolio plan, and savior plan.
- Full control. With this method, the private equity firm buys 100 percent of the company and takes full control over all business decisions. This allows them to accelerate growth, maximize revenue, and provide robust returns for investors. Full control deals usually only happen with the private equity firm has a strong expertise in the business’ industry (or has experienced partners in that area).
There are literally dozens of different strategies and monetization structures, but these are a couple of common ones. Ultimately, it all comes down to the individual deal.
The Risks of Private Equity Investments
Investing in private equity deals can be highly lucrative. However, these deals also carry a fair amount of risk. This may include any or all of the following:
- The privacy equity fund itself must be stable. Funds with unproven track records often face solvency issues and may be forced to eventually declare bankruptcy.
- There’s always the risk that the business itself – meaning the business that the private equity is investing in – could flop.
- It’s possible that the firm could overpay for an acquisition, which minimizes the potential for growth and prevents you from getting the returns you were targeting.
How to Invest in Private Equity
Private equity has massive upside, but it’s not foolproof. It ultimately comes down to partnering with the right private equity partner so that you can access the best deals. (Private equity due diligence is also key.) Here are several helpful tips if you’re just getting started:
1. Identify a Strategy
The process starts with identifying the strategy or approach you want to take. As previously mentioned, there are a number of unique approaches. You can invest in growth equity, leveraged buyouts, or even venture capital. LBOs are by far the most common – particularly if you’re just getting your feet wet in private equity.
2. Find a Focus
The next step is to find a focus. In other words, is there a specific niche, company size, or business model that you want to focus on. Private equity managers typically do better when they niche down, so you’ll want to to think about this when identifying the right firm. Lower-middle market is usually a pretty good sweet spot.
3. Choose an Amount
What amount are you comfortable investing? (And what amount does the private equity company require in order to bring you in.) The amount you’re able to invest is obviously highly dependent on your unique circumstances. It can also depend on the deal. Technically speaking, only accredited investors with a net worth of at least $1 million are legally allowed to invest inp private equity.
4. Understand the Fee Structure
In order to be a successful investor in private equity, you must have an understanding of the fees involved. Generally, a private equity manager will employ some variation of the “2 and 20” fee structure. This means there’s a 2 percent management fee on the total capital in the fund each year. Then there’s another 20 percent payment on returns generated. This structure can vary based on the competitiveness of the market, but it’s a pretty standard starting point.
Partner With InvestNet
At InvestNet, we make the process of finding private equity investing opportunities more accessible to investors. We do this by implementing a strategic approach that allows us to target, source, and operate private equity investments.
With our unique approach, you get access to private, off-market deals in the lower middle-market. This gives you greater exposure to untapped opportunities. We leverage a variety of investment types, including management buyouts, corporate recapitalizations, acquisition capital, and majority equity positions.
Want to join our investor network? Contact us today and we’d love to chat!
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