Key Takeaways
Private equity is an investment in a privately held company.
Public equity is when you hold shares of a company that is listed on a public stock exchange.
Private equity investments are available only to high net worth and institutional investors, whereas investors of all types can own public equity.
Private equity can generate greater returns, but comes with unique risks, including illiquidity, high management fees, and long holding periods.
What is Private Equity?
Private equity is an investment in a company (or group of companies) that isn’t listed on a public stock exchange. The capital comes from investors with high net worths, otherwise known as accredited investors, and institutional investors, such as hedge funds, large mutual funds, or endowments.
A private equity fund pools capital from multiple investors to invest in a private company with the goal of adding value. These funds are typically structured as limited partnerships, which means investors are only liable for the amount they invest in the fund. Private equity funds are run by general partners, who choose investments and manage the fund. As such, general partners can be held responsible for potential debts if the fund goes red.
Private equity funds charge fees for management and performance. The typical management fee is about 2%, and covers operations and administrative costs for the fund. The performance fee, which is only charged when the fund produces a positive return, can be much higher.
Private equity investments can generate much higher returns than traditional asset classes, but have relatively lengthy holding periods, usually from five to 10 years or more. They also may require additional investments over time, as opposed to one, large initial investment.
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What qualifies as private equity?
Private equity is funds raised from private investors, off of a public stock exchange. Venture capital is a popular private equity investment strategy in which wealthy investors or firms cut checks to startups with growth potential. In exchange, they receive some shares of the company. By the time the company goes public, the value of their shares has usually multiplied.
Another strategy is growth equity, wherein private equity investors analyze the performance and financials of established private companies and make investments in those that show continued growth potential but need funding for expenses like hiring more employees or leasing office space.
Can a private equity firm go public?
Private equity firms can go public to raise more capital from a wider pool of investors. According to S&P Global Market Intelligence, the number of private equity firms that went public nearly doubled from 2020 to 2021, with the majority occurring in Europe. Experts predict, however, that IPO activity will slow down as markets stabilize.
Does private equity outperform public equity?
According to a 2021 McKinsey report, private equity has outperformed public equity consistently in the last two decades. Over a 10-year period, private equity generated annualized returns of 14.3%, while the S&P 500 — a reasonable benchmark for the public market — returned 13.8%. Further, over a 20-year period, private equity produced a 9.9% annualized return, while the S&P 500 returned 6.4%.
But there are risks in private equity investing that aren’t present in public equity investing, which is one reason why it’s exclusive to wealthy investors. Risks include illiquidity, high active management fees, high investment minimums, and long holding periods.
What is Public Equity?
Public equity investments are shares of a public company that’s listed on a stock exchange, such as the New York Stock Exchange or the London Stock Exchange. Public equity is available to all types of investors, regardless of net worth. Public companies have to follow a strict set of rules, which involve disclosing business activity and financials to the public, since they have a vested interest in the company or may in the future.
Public equity investing is attractive for a few reasons:
Liquidity: Public shares of a company can easily be bought or sold on a public exchange within minutes or even seconds. There’s little to no secondary market for private equity.
Transparency: Public equity markets are heavily regulated, protecting investors against unforeseen risks.
Growth: Not all companies listed on public stock exchanges are successful, but they have to reach a certain level of growth to go public. Over time and taken as a whole, the stock market tends to rise in value over time. Since 1928, the S&P 500 has had an average annual return of 10%.
What is an example of public equity?
Buying individual stocks is an example of a public equity investment. Mutual funds and exchange-traded funds give investors exposure to public equity too, as well as some built-in diversification since ownership is spread over multiple companies or industries.
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Special Considerations
Most private equity firms have investment minimums ranging from $250,000 to $25 million, making private equity an exclusive asset class to invest in directly. These firms also often require investors to commit to a five-to-10 year investment.
There are ways to invest in private companies indirectly. Funds of funds and exchange-traded funds offer investors the opportunity to earn downstream returns with a smaller initial investment. These funds are made up of shares of public companies that are invested in private companies, so there are a few layers of management expenses to consider.
Next Steps for You
Private equity investing is best navigated with the help of an investment professional. Clients with at least $5 million invested with Personal Capital can schedule a live call with a financial advisor to explore their options.
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Author is not a client of Personal Capital Advisors Corporation and is compensated as a freelance writer.
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. Compensation not to exceed $500. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.
