How do buyouts, venture capital, and growth equity work? Has private equity outperformed the stock market, and can individual investors pursue these investment strategies?
Topics covered include:
- How are private equity funds structured, and what are the fees
- How is private equity performance measured, and how has it performed
- Why does private equity have such a large dispersion of returns compared to the public stock market
- What is private equity dry powder, and why is there much of it
- What are some ways individuals can invest in private equity and why should they use caution in doing so
Show Notes
Understanding Private Fund Performance by Kaitlin Hendrix and Mamdouh Medhat—SSRN
Private equity dry powder growth accelerated in H1 2024 by Dylan Thomas and Annie Sabater—S&P Global
Private Equity Gets Creative to Buy Time for More Gains. Clients Say Pay Me Now by Allison McNeely and Dawn Lim—Bloomberg
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 490. It’s titled, “Should You Invest in Private Equity?”
Recently, I received an email from a member of our premium community, Money for the Rest of Us Plus. He was asking about private equity, and he pointed out that in much of the world, the stock market is expensive, and investment money is looking for opportunities. Yet there is a lot of capital already raised to invest in private equity, and he was curious whether that would impact returns. How has private equity performed?
And we’re going to discuss that in this episode, including what is private equity, and can we as individuals participate in this asset category that has been very successful for institutional investors. Private equity consists of really three areas: buyouts, growth capital, and venture capital.
Buyout Funds Defined
Buyout is when a fund or investors acquire a publicly traded or even a private company outright, and they’ll often use debt. They’ll borrow money to help finance that purchase. That’s why buyouts are sometimes called leveraged buyouts.
The management team is actively involved in this company purchase to improve operations, to grow the business. But these are typically established businesses, that have been around for a number of years, and most of the time, they’re publicly traded. So they have publicly-traded stock; the fund might raise capital to purchase that publicly-traded company and take it private.
Venture and Growth Capital Defined
Venture capital is different. This is equity investments focused on early-stage companies, startups, that have high growth potential. And then as these startups perform, they build out their businesses, oftentimes there can be additional capital, known as growth capital, that are invested in these later-stage companies. Venture capital and growth capital is investments in private companies.
And with all of these strategies—the buyouts, the growth capital, the venture capital—the idea is to have some type of exit so that the investors can get their money out and lock in their profits. And those exits come through an initial public offering, taking this private company and issuing publicly-traded stock, or it could be done through a buyout. Some other fund can come along and purchase the company.
How Private Equity Funds Work
Traditionally, private equity investment has been done through a private fund structure, with a general partner that is with the management company, and they are the ones that put the fund together. They go out and they raise capital from limited partners.
So a limited partner could be a university endowment, a private foundation, it could be a family office, or a very high net worth individual. These partnerships typically last 7 to 10 years, but they could go longer than that if there are remaining investments where there’s been no exit. I am in a private equity or private capital fund of funds from my former firm, and it’s gone on for 12 years, and they’ve just extended for another year. And so oftentimes, these funds can last more than a decade.
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