What is private investing?
Unlike publicly traded securities, private equity investing is an alternative investment where individuals own a portion of a private company. Investors seek out private equity investing with the hope that these faster-growing companies will deliver better returns than public companies.
Historically, private investing was for wealthy, accredited investors and required investments ranging from $250,000 to $25 million. This is changing today. In addition to the high financial entry, private equity investing is typically illiquid. So, don’t invest funds in private equity that you’ll need to use within the next year or so.
University endowments, wealthy families, and foundations invest in private equity with the hope that these new ventures will have massive growth. Over the past several years, A&W Restaurants, Harrah’s/Ceaser’s Entertainment (NASDAQ:CZR), Cisco Systems (NASDAQ:CSCO), and Intel (NASDAQ:INTC) benefited from private investing.
If you don’t have $250,000 or more ready to invest in private equity, you might consider a fund.
According to the SEC website, a private equity fund is similar to a mutual or hedge fund that solicits capital from individuals to invest in non-public or private entities. A private equity fund might invest in real estate, early-stage, and risky ventures.
This capital infusion allows companies to expand more rapidly, albeit, at a cost. Private equity funds are known for greater risk and higher expense ratios.
How to Invest in Private Equity
There are a variety of ways to invest in private equity beyond direct investments. These include opportunities for both wealthy accredited investors and non-accredited smaller investors.
- Private Equity Exchange Traded Funds
ETFs have opened the door to many investment opportunities, and private equity investing is no exception. Private equity ETFs typically track an index of publicly traded companies that invest in private equity. Think of it as joining in with those that pick and choose private equity investments.
Since ETFs are publicly traded and require no minimum investment, anyone can invest in them. As with any type of investment, investigate the fee structure. Private equity ETFs may charge a hefty management fee along with any brokerage commission.
The private equity ETF market is small with total assets under management of $425.32 million, as of October 2019.
The largest private equity ETF is VanEck Vectors BDC Income ETF (BIZD) with a 9.62% expense ratio. Invesco’s Global Listed Private Equity ETF (PSP) charges 1.78% AUM expense ratio, while the ProShares Global Listed Private Equity ETF (PEX) levies 3.13% AUM.
- Private Equity Fund of Funds
These investments hold a portfolio of other funds. This gives the investor broad diversification, though the fee structure is pricey. The private equity FOFs typically charge an annual fee of approximately 1% and management receives 5% of all gains. This fee for the FOF is on top of the hefty fees of the underlying funds.
Whether the ultimate returns after fees are worth the investment depends on the particular fund. As with private equity ETFs and any other high fee investment products, you’re betting on outstanding returns that will substantially overcome the management fee.
Large institutions, foundations, and endowments may have the staff to properly vet these investments. Individual investors need to weigh the risk and costs for investing in a private equity FOF.
- Private Equity Crowdfunding
Similar to sites like Kickstarter, which raises capital online, private equity crowdfunding offers the small investor a way to fund private businesses. This type of private investing is convenient and direct.
The entrepreneur puts out an offering and the investor visits the website to select an investment. Restrictions usually apply; investors must be older than age 18, and the investment amount is restricted by the individual’s net worth and income.
Initial investment amounts can start as low as $50, although a $1,000 minimum is more common. Other offers are for accredited investors only.
Several private equity crowdfunding platforms include SeedInvest, Localstake, and StartEngine.
A visit to the SeedInvest platform showed these offers: NowRX, a technology-driven, on-demand pharmacy that provides free, same-day delivery; CellarStash, a direct-to-consumer online wine marketing company; and Graze, an electric, autonomous commercial lawn mower.
The platform identifies other investors, revenue growth, and amount of capital raised. As with other private equity investment opportunities, always investigate fees. SeedInvest charges all investors a 2% non-refundable processing that will be refunded if the company doesn’t reach its fundraising goal.
These are illiquid investments which might not yield a return of capital until after five years or more.
Private Equity Investing Wrap Up
Private investing is for the speculative portion of your portfolio. While investing in publicly traded securities is risky, private investing is more so. These companies have limited track records.
It’s exciting to search out the next biggest idea, but according to Fundera, 20% of small businesses fail in their first year, 30% in their second, and 50% in five years. 70% fail in their 10th year in business. So, know your odds when treading into the private equity investment market.
Barbara A. Friedberg, MBA, MS is a veteran portfolio manager, expert investor, and former university finance instructor. She is editor/author of Personal Finance; An Encyclopedia of Modern Money Management and two additional money books. She is CEO of Robo-Advisor Pros.com, a robo-advisor review and information website. Additionally, Friedberg is publisher of the well-regarded investment website Barbara Friedberg Personal Finance.com. Follow her on twitter @barbfriedberg and @roboadvisorpros. As of this writing, she does not hold a position in any of the aforementioned securities.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.