Private Equity as an Alternative Investment

Alternatives are an asset class that includes any securities that aren’t stocks, bonds, and cash. While this can cast a wide net and include many different types of possible assets and holdings, ranging from shares of hedge funds to the collectibles in your basement, a well-known alternative investment option is private equity.

In this article, we’ll explore how private equity works as an alternative investment, including a description of the different forms it can take. In addition, we’ll pinpoint how it can fit into your portfolio, especially if you’re a high-net-worth investor. Finally, we’ll break down the benefits and drawbacks of this kind of investment.

What Is a Private Equity Investment?

Private equity is an investment category that involves funding any privately held company — that is, any not available to most retail investors. Because these companies aren’t available to the public through avenues such as the stock market, experts classify investing in one as an alternative class.

“Generally, anything that isn’t a market-listed security is considered ‘alternative,’” explains Matt Willer, Managing Director of Capital Markets and partner at Phoenix Capital Group Holdings, LLC. Therefore, he notes, private equity “falls into that category.”

At its core, investing in private equities is when a person or an entity, such as a venture capital firm, gains an equity stake in a corporation. But unlike investing in public companies, which you can easily do on a stock exchange such as the Nasdaq, funding private companies takes more nuance and includes various approaches.

As we’ll detail in the next section, there are three primary methods of investing in private equities. However, it’s important to note that many are largely inaccessible to average investors. While there are many reasons for this, it’s often because private equity investments require significant capital and, in some cases, are only available to accredited or institutional investors.

Adding private equity to your portfolio can have some benefits, especially in their potential for high return on investment (ROI), diversification, and ability to have some say in the performance of your holding. However, they’re not without their drawbacks. For example, Willer highlights illiquidity as a potential pitfall.

“The benefits [of private equities] are clear, the returns are typically quite favorable, and it allows you to diversify from market-based investments,” Willer says. “The drawback is typically liquidity and hold periods. Expect the funds to be tied up for several years, albeit each firm has its own strategy.”

Types of Private Equity Investments

Private equity is a wide category of investments, but there are typically three forms it can take. Each involves either the funding of a company at an early or further stage or gaining complete ownership.

Consider, though, that most of these investments are only possible for high-net-worth individuals with sufficient resources. Private equity firms are also another source of funding for privately held companies. Per Willer, “There are many different types of private equity firms based on their thesis, their size, or industry focus.”

Here is a breakdown of the main types of private equity:

Venture Capital

A common type of private equity investment is venture capital (VC). This is when an individual or organization invests in a startup or fledgling company. Often, a company’s founder(s) will seek out a VC firm or wealthy investor and pitch their idea and vision, hoping for an investment.

VC investors typically don’t earn a majority stake in the startup companies they invest in unless the founder desires it. However, depending on the deal and strategic advantage an investor carries, they may be able to command a higher equity.

Because it occurs at such an early stage of a company’s lifespan, VC investments can be risky for investors. Not every idea will pan out due to many factors, including operational issues, competition in a niche, lack of sufficient funding, or legal challenges. According to a September 2023 article published in The Harvard Law School Forum on Corporate Governance, despite receiving investments from investors, 75% of startups backed by VC fail.

Growth Equity

Another type of private equity investment is growth equity. This involves an investor funding a growing company with a track record and measurable data, usually when the company forecasts a period of expansion or growth.

For instance, a business may experience an increased revenue period and want to onboard staff, open another location, or launch a new product. In this case, they would seek an investment from a firm or angel investor to help propel their plans and reach their goals.

Growth equity is potentially less risky for investors than venture capital. One reason is that with the former, investors can review a company’s performance and make more calculated decisions. On the other hand, VC can tend to be more speculative and more prone to failure, despite the potential for high returns.

Buyouts

Buyouts are a third method of private equity investing. Simply put, it involves gaining a complete controlling interest in the company. In this way, the investor or equity firm becomes the owner or majority stakeholder of the business.

Acquisitions of a company may occur in several scenarios. Sometimes, a business may be experiencing troubles for many reasons — such as being in debt or operating at a significant loss — and may search for a buyer. In other cases, a buyer may approach another company because it’s successful and make an offer.

Pros and Cons of Private Equity

If you’re able, there are several reasons to consider private equity. For instance, it allows you to diversify your portfolio and gain more control over how an investment performs. However, it does have its set of drawbacks, especially in its inaccessibility to regular people and potentially high risk.

Below are the pros and cons to consider:

Role in an Investor’s Portfolio

Investing in private equity, as noted, is largely not possible for everyday investors. This is because, unlike buying shares of a public company, you would need to be able to offer a private company a substantial sum of money in exchange for equity. Even in startup stages, founders usually want lofty investments to kickstart their business.

“Often, these types of investments are challenging to find as a retail investor as they are typically high minimums and geared toward high net worth families and institutions,” Willer explains.

As Willer highlights, private equity investments become possible if you’re a wealthy investor with more capital to work with. If this is you, then it can be a good opportunity to diversify your portfolio and position yourself to potentially see high returns, although usually over a longer period.

Frequently Asked Questions

What is a private equity fund?

A private equity fund is an investment vehicle where individuals or organizations pool their funds to invest in privately held companies or investments. The only types of investors that can invest in one of these funds are usually accredited investors that meet a minimum net worth threshold or certain requirements and institutional investors, such as pensions, banks, and insurance companies.

Are there different types of private equity?

There are three distinct broad types and corresponding subsets of private equity investments, all of which are usually only accessible to high-net-worth people and institutions. Specifically, the three forms are:

• Venture capital (VC)
• Growth equity investments
• Buyouts

What are the largest private equity firms in the world?

The largest private equity firms come from several countries; however, most in the top ten are based in the United States and have billions of dollars in funds. Below is a list of the largest firms in 2024, according to Private Equity International (PEI):

1. Blackstone
2. KKR
3. EQT
4. CVC Capital Partners
5. TPG
6. The Carlyle Group
7. Thoma Bravo
8. Advent International
9. Warburg Pincus
10. Hg