In times of stock market uncertainty, investors often seek alternative investment avenues that provide similar benefits to the public stock market but with less direct stock market exposure. Endowments and high-net-worth families frequently turn to private equity for its potential to deliver stock market upside while mitigating stock market risk. If you’re unfamiliar with private equity, you can start with this article for an in-depth introduction.
Headquarters of venture capital investment firm Kleiner Perkins Caufield Byers, on Sand Hill Road in … [+]
Types of Traditional Private Equity
1. Venture Capital (VC) Venture capital involves investing in startups at their early stages, making it the riskiest form of a private equity investment. However, diversifying across multiple startups increases the chance of substantial returns, as only one successful venture is needed to compensate for other failed investments.
2. Leveraged Buyouts (LBOs) Leveraged buyouts are the most recognized private equity deals, often highlighted in the news. These deals involve private equity firms raising significant debt—typically around 90% of the purchase price—to acquire a controlling stake in a company. While leverage can amplify returns, it also increases potential losses. LBOs usually target struggling companies, providing the financial mechanisms needed to restructure and revive the business.
3. Growth Equity (GE) Growth equity targets growth-stage businesses with more historical financial data than VC-backed startups but less than those targeted in LBOs. GE firms typically seek minority ownership, making it an attractive option for private firms that want additional capital without going public.
Challenges of Traditional Private Equity Private equity investments can have a bad reputation, and it’s not hard to understand why. When private equity firms buy companies, they aim to make more money. To do this, they often combine companies or cut costs. Sadly, this can lead to people losing their jobs because of layoffs. Mergers and changes in ownership can also make things uncertain for the workers who stay, as they don’t know what’s coming next. Even though these moves can help the business make more money, the usually unquantified human impact also needs to be factored into these decisions.
This map visualizes the leading private equity firms of major countries, ranked by capital raised … [+]
For an individual investor, private equity comes with some big challenges. It can be considered a very risky investment. Unlike stocks, where you can sell your shares if things aren’t going well, private equity often requires you to stay invested for many years. This is called a “lock-up” period, and during this time, you can’t easily take your money out, even if you want to. This makes it hard to react to changes in the market and address your own financial needs.
Returns can also take time, and nobody likes to wait. When you invest in private equity, it might take years before you make any profit. This can be frustrating, especially if you’re used to other investments like stocks or bonds, where you can make (or lose) money faster.
Hefty fees are also unpopular. Private equity firms usually charge high management and performance fees, which can take a big chunk out of any money you make. These fees are generally much higher than what you’d pay with other types of investments, like mutual funds or ETFs. When firms who offer private equity funds to their clients research what programs to use, the good firms review the fees as part of their due diligence. However, don’t let the fees scare you. In life you “get what you pay for” and private isn’t an easy job and the fees reflect that work and the windfall that can occur when the PE firm is good at their job. In addition, unlike the stock market, PE can be selective in what they buy and will only buy firms they already have a plan to turn around. Compare that to the stock market thesis of “buy and hold and hope.” Most large institutions have had (and still do have) a large allocation to private equity and that is for a good reason.
Photo Illustration European Private Equity Firm CVC Capital Partners Partners, on July 22, 2023, in … [+]
Finally, private equity is accessible to only a segment of the population. It’s mostly for accredited investors, which means you need to have a certain amount of wealth or income to participate. This makes it hard for regular people to invest in private equity, making it feel like an exclusive opportunity out of reach for most. Accreditation is $1M of net worth, not counting your primary home or individual income of $190K and $300K of joint income. You can be accredited if you either have the income or the net worth, you don’t need to have both.
The Rise of Private Capital An Alternative to Private Equity
Private capital has emerged as an alternative, addressing many issues associated with traditional private equity while expanding access to non-accredited investors.
Private capital can involve both private debt and private equity. Unlike traditional private equity, where returns are often delayed until a company is sold, private debt offers immediate payouts, similar to bonds. Private capital focuses on growing high-quality, established companies that do not need a turnaround, resulting in a less risky investment than struggling companies.
Private capital firms typically do not take ownership of the companies they invest in, making them more attractive to businesses—especially those owned by families. This structure allows the existing management team to remain in place, which is often preferred in family-owned companies.
Opportunities for Private Capital Post As Alternative for Private Equity
Post-COVID and with many baby boomers who founded companies looking to slow down, private capital has a significant opportunity. Assuming you are a successful, profitable, private company and the founders want to cash out but do not take the company public or invite a turnaround private equity shop to come in and change everything, private capital may check all the boxes.
When exploring private capital investment opportunities, investors should look for managers with a proven, profitable track record, especially during volatile periods like election cycles.
Securities are offered through Arkadios Capital. Member FINRA/SIPC. Advisory services are offered through Creative Capital Wealth Management Group. Creative Capital Wealth Management Group and Arkadios are not affiliated through any ownership.
This material was created for educational and informational purposes only and is not intended as tax, legal or investment advice.
