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How Private Equity Works

When investment options that are most accessible to the investing public seem volatile or uncertain, investors may look to other options that are independent and uncorrelated to the stock and bond markets. Private equity provides an opportunity to gain exposure to alternative investments that are not available on public financial markets. Because the performance of an alternative investment in something like private equity is not linked to market performance, adding diversity to your portfolio via an alternative investment strategy is something you may want to think about.

What is Private Equity?

Private equity is a method of investing that occurs outside the public market, allowing investors to acquire an ownership stake in private companies. With private equity, individuals generally invest their money with a private equity firm, which pools that money with other investors’ money to invest in private equity instruments, such as private debt or venture capital.  Private equity firms will often provide capital to companies that they believe have potential to grow or expand with the hopes of taking those companies public or selling their ownership interest for a higher valuation.

Usually, investors in a private equity fund are limited partners that exchange their capital for a portion of ownership in the fund. In this scenario, the fund’s general partners would be responsible for actively managing and controlling the fund’s investments.

Who Can Invest in Private Equity?

Typically, private equity funds are restricted to accepting investments from accredited investors and qualified clients.

An accredited investor is defined as any natural person whose individual net worth, or joint net worth with that person’s spouse exceeds $1 million. The accredited investor definition also includes those who earned at least $200,000 in income in each of the previous two years, which is increased to a minimum of $300,000 for those that filed a joint tax return with a spouse.

A qualified client is an individual whose total net worth is at least $2.2 million. This net worth calculation must exclude the individual’s primary residence but allows the inclusion of a spouse’s net worth for married couples.

Growth of Private Equity

The demand for private equity continues to grow rapidly. Although still much smaller than traditional public financial markets, the private equity industry was estimated to have $4.5 trillion in assets under management (AUM) at the end of 2019, according to a study by Deloitte. In the same study, Deloitte forecasts that the total AUM for the global private equity industry could reach $5.8 trillion by the end of 2025.

Institutional investors remain a significant contributing factor to this growth. In 2020, 66% of institutional investors invested in private equity, up from 57% in 2016. This demand for private equity investing may be derived from investors’ desire for high returns that are hopefully accompanied by low volatility. Additionally, retail investors have newfound access to private equity due to recently passed regulations.

Want to Know More?

While the appetite for private equity continues to surge, private equity firms will need to continue capitalizing on investment opportunities poised for growth. Are you considering private equity as an alternative investment strategy to add to your portfolio? A financial advisor can provide information and clarity about opportunities eligibility to invest in private equity.

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