Private equity is an asset class that involves buying stake in companies that are not publicly traded. It is generally purchased through a private equity firm, a venture capital firm, or an angel investor. Investing in the right company in its infancy can be extremely lucrative but knowing about private equity is essential in this process. Getting involved with private equity investment today means getting involved in the newest investing trend and making a potentially fruitful investment.
Investing in private equity is an alternative way to participate in primarily long-term investments. In the modern market, this asset class has a much higher ceiling for ROI due to traditional stocks being rather subdued. While the price volatility and risk involved with private equity are higher than those in their public counterpart, the median 10-year return in private equity from 2005 to 2015 was 11.8 percent whereas the S&P 500 had only increased 6.8 percent in that same span according to the Private Equity Growth Capital Council.
A private equity investor having industry knowledge as well as diligence can provide a huge advantage over others. This is the result of a company potentially being critically undervalued due to the lack of valuation on many private companies. An investor can then do their own analysis and make a decision based on the product or service offered by the firm, possibly making the choice to invest.
Much of the success (or lack thereof) of these assets is due to the quality of company management. Upper quartile managers massively outperform the public MSCI World–Morgan Stanley’s index of 1,650 companies from 23 countries. This gives savvy investors another tool to beat the market: by identifying private companies with top managerial talent.
Private equity can also allow investors to take on a role with the firm they are funding. Because of the smaller size of private companies, each investor could play a much more significant role as a shareholding decision maker.
So, What’s the Catch?
Arguably the most significant issue with privately-traded companies is that only about one in six ever become profitable. While investing always comes with risk, private equity comes with more than most. However, with the proper research, the potential rewards are very high as well.
Another difficulty of private equity investing is a lack of liquidity. Investments often take five to ten years before there is any return. Because of this, a potentially large amount of money can be unavailable to the investor for a long time.
Sometimes information can be hard to find as well. This can make private equity perilous, as accurate information is critical to picking investments. This is amplified when company managers have technical backgrounds, but are not familiar with what information investors need.
Private Equity Today
Private equity investments are increasing in both frequency and size. Last year, private equity investing hit an all-time high of $681 billion, a nine percent year over year increase. At the beginning of 2017, Forbes predicted that the upward trend would continue and that the 2015 record of $681 billion would be surpassed for another record-breaking year.
Today institutional investors are targeting companies that they predict will produce an exit via acquisition, resulting in a payout for investors. According to a study done by Provitas Partners, in the past 10 years there has been an increase from 45 percent to 77 percent of institutional investors that target middle-market buyouts, as well growth from less than 25 percent up to 56 percent looking for small-market buyouts.
The United States has always been the frontrunner for the most private equity investments simply based on the ease of starting businesses here, however new markets are emerging. According to a survey of 84 institutions, the most anticipated market that they will be investing in is China, followed by four other countries in Asia. The sixth most positively forecasted market is Brazil. This is a reflection of globalization in finance and the development of international markets.
The risk involved with private equity is certainly higher than with publicly traded stocks, however this risk can be — to a degree — mitigated by knowledge of a sector and due diligence on the part of the investor. The potential returns that come with the private sector are extraordinarily high and can outweigh the costs.
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