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How to Invest in Private Equity

By Dan Caplinger – Updated Apr 25, 2018 at 11:17AM

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Many investors see private equity investments as a gateway to the most lucrative opportunities in the financial markets. The professionals who run private equity companies raise substantial amounts of capital from investors, sometimes use the money as collateral to borrow more capital, and then go out to buy companies that are particularly attractive. Private equity typically purchases entire companies rather than taking a partial equity interest, and companies whose stock is publicly traded prior to a private equity buyout are typically no longer available in the public markets after the buyout. Therefore, to invest in private equity, you have to ask the following questions:

  • Do you meet the Securities and Exchange Commission's definition of an accredited investor who can invest in private equity funds?
  • If so, is there a private equity fund accepting new money that will take you on as an investor?
  • If not, are you willing to participate indirectly by investing in a private equity management company?

What the SEC wants

The SEC wants only qualified investors to be able to invest in private equity. Private equity investments aren't subject to the same level of disclosure requirements as publicly traded companies, and so public policy dictates that only those investors who have the level of sophistication to be what the SEC calls accredited investors can participate.

In defining the SEC standard, "sophistication" basically means money. In particular, accredited investors must have:

  • Income of $200,000 for singles or $300,000 for joint couples in each of the past two years;
  • A net worth of more than $1 million, not including your home's equity; or
  • Being an officer, director, or general partner of the company in which you're investing.

Those who qualify under any of those standards can satisfy the SEC. But that doesn't mean you'll necessarily be able to get into the private equity investment you want.

Wall Street street sign in front of New York Stock Exchange.

Image source: Getty Images.

Finding a match

Being an accredited investor might be a necessary condition to be part of a private equity deal, but it's not sufficient to gain admittance into the private equity fund of your choice. Different private equity funds have different standards for participation, along with different levels of capital commitment. Highly successful established private equity fund managers typically have no problem attracting capital for future investments, and so a new investor might find it impossible to break into the fund's ecosystem.

By contrast, if it's too easy to get into a private equity fund, an investor should be cautious. Newly established funds have to build a reputation, but some longtime providers have developed bad reputations that make them more willing to accept less experienced investors just to get the capital they need. That will rarely be the right fit for you, especially if it's your first foray into the private equity world.

Investing in private equity managers

Because of the uncertainty of investing in private equity funds, some investors prefer instead to buy shares of the companies that manage the funds. You can find some such companies, such as KKR (KKR -0.53%) and Blackstone Group (BX), publicly listed on major exchanges.

When times are good for private equity funds, their managers also participate by taking a cut of their profits, and that benefits shareholders. However, investing in a manager doesn't let you drill down on particular fund focus areas, leaving you exposed to the success or failure of the management company as a whole. That can lead to a better diversified portfolio, but it makes it impossible to generate the truly massive returns that a well-focused private equity fund can produce when its investment philosophy proves to be fortuitous.

Private equity has a reputation for high-end treatment and wealth generation, and it's an exclusive area into which many investors can't go. Even if you qualify, take a close look at private equity to ensure that the funds you pick fit well with your expectations and financial needs.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends KKR. The Motley Fool has a disclosure policy.

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