Start Here – Private Equity for Individual Investors

Private equity, long reserved for institutional investors and high-net-worth individuals, is becoming an increasingly accessible option for individual investors looking to diversify their portfolios. However, understanding private equity and how to invest in it can feel like navigating a complex landscape.

You’re in the right place if you’re an individual investor interested in exploring private equity opportunities. In this guide, we’ll break down the essentials of private equity for individual investors—covering everything from the basics to potential risks, rewards, and the pros and cons of adding this type of investment to your portfolio.

Whether you’re looking to make more informed investment decisions or you’re just curious about how private equity works, this is your starting point.

OK, So Why Should I Be Interested in Private Equity?

There are two main points of interest related to private equity for individual investors interested in capital markets:

1. The overall balance between public and private equity tells us quite a bit. Right now, the growing share of private equity tells us that a lot of investments (e.g., small growth companies) that would have been part of the public equity world in the past are remaining private now.  This is an important shift with some interesting implications.
2. As an investor, you may be investing in private equity or you may be seeing new products aimed at investors who were not eligible to invest in private equity before, something to consider very carefully before jumping in.

A Little Background on Private Vs Public Companies

After the Great Depression, in which many people lost everything in volatile and speculative markets, significant regulation was passed that required greater transparency from public companies to better protect investors.  Let’s skip the details about all the regulations, of which there are plenty, and get to the main point.  Private companies are not as heavily regulated as public companies, but there are restrictions that prevent most people from making such investments because they would not have the benefit of all the disclosures and regulations governing public companies.

The Securities and Exchange Commission (SEC) created several categories of investors who are considered “sophisticated” enough to invest in private securities of various kinds.  These include Accredited Investors and Qualified Purchasers.  That being said, the Accredited Investor category, which you can reach with as little as $200,000 of annual income as an individual and $300,000 joint income with a spouse or partner (depending on a few factors), has not been updated in a long time, and many private investments are not open to those people anymore.¹“U.S. Securities And Exchange Commission.” sec.gov, 19 Sept. 2024, www.sec.gov/resources-small-businesses/capital-raising-building-blocks/accredited-investors.

Individuals who qualify as Qualified Purchasers must have a minimum of $5 million in investable assets.²“Defining the Term ‘Qualified Purchaser’ Under the Securities Act of 1933.” sec.gov, 25 May 2023, www.sec.gov/rules-regulations/2001/12/defining-term-qualified-purchaser-under-securities-act-1933. This excludes your home or property used for business.  These people/families, along with institutional investors, are the main private equity investors.

How Big Are Private Markets Versus Public Markets Anyway?

The private equity market is expected to grow to $12.5 trillion by 2025.³Baer, Justin. “What Private Equity’s Rise Means for Your Stock Investments.” The Wall Street Journal, 12 July 2022, www.wsj.com/articles/what-private-equitys-rise-means-for-your-stock-investments-11657636263?mod=hp_lead_pos13. This compares with about $46 trillion for U.S. public equity ($78 trillion global public equity).⁴DFA Global Market Breakdown Report. Pg 2. Meanwhile, the total number of U.S. public companies is not rising, as many stay private longer, seeking to grow larger before they go public, and many never have an IPO at all, but are simply acquired by a tech giant.

The Russell 2000 Index, representing small-cap public companies, is now roughly 8% of the total market cap of US equities,⁵Morningstar Direct. Data as of 7/13/2022. Based on full replication Russell 3000 index ETF. even as the boundary between large cap and small cap has risen to more than $5 billion!  Not too long ago, small cap was defined as less than $1 billion.  Where did all the small-cap companies go?

Summary – private equity is growing fast, and a lot of companies that would have gone public in the past are remaining private and accessing capital privately.  Also, private equity is used to take some large (or not so large) public companies private with the intention of fixing them. These transactions are called “buy outs.”

What Does This Mean to Me, as an Individual Investor? 

Even if you are not engaged in private equity investing, this is useful information about changes in the composition of the public stock markets.

One area in particular that has been affected is small-cap equity.  We recommend a consistent long-term overweight to small-cap equity, and right now that overweight is large relative to the weighting in public market indices.  And the small cap companies are larger than they used to be.  We will have to see what that means over time, but it is certainly interesting.

As a current or prospective investor in private equity, there is a lot more to consider.  Our intention is to summarize the issues briefly here. If you are looking to become an individual investor in private equity, or are simply interested in the topic, there is a lot to discuss, and we look forward to it.

Prospects for Private Equity

Here are some of the fundamentals to consider.

• Private Equity Management

Private equity has generally been a market in which the best managers, the so-called “top quartile,” outperform the rest consistently and pretty substantially.  You can’t “index” private equity.  A successful strategy requires access to strong managers. Otherwise, it is probably not worth the risk. 

• Options for Smaller Investors

Parts of the market, such as small- to mid-buyout, require relatively small amounts of capital, because the companies are small.  These are therefore of no interest to the huge institutional investors that need to put billions of dollars to work.  Thus, these areas are less competitive and have offered better opportunities to “smaller investors” who seek to invest smaller amounts (e.g., less than $50 million) in private equity. 

• Find the Right Opportunities

Investing with strong managers in smaller funds doing smaller deals has historically produced good returns.  But you have to find those opportunities; they will not come looking for you. 

If you think about it, most of the private equity offerings are huge–they have to be.  How would Blackstone or Merrill sell billions of dollars of small investments?  And without a big markup?  Not possible.  We think that such large funds produced for the mass market would seem to face strong headwinds and may well be doomed to risky and expensive mediocrity.  If someone is knocking on your door with private equity to sell you, it may well be because no one else wants it. 

Geez, Sounds a Little Daunting… Is Private Equity Worth It? 

We should add that private equity is illiquid, expensive, and risky.  Eyes wide open, you have to accept that, or you should not invest in it.  Anyone who tells you otherwise is selling something and does not have your best interest at heart. 

But if done well, the long–term returns may be substantially better than those offered by public equity.  Over time, on average, successful private equity investors have gotten paid for taking the risk.  That is why people do it.  But it has to be done well, and you should fully understand what you are getting into. 

A side note: we have had business owner clients meet with some of the buyout fund-of-funds managers we research, and it is interesting to listen to the conversation, as buyout investing in private equity is really just investing in companies that have problems and opportunities.  Business owners readily understand how that works.  It is not magic; it is making a good deal and executing on business strategy.  Nothing mysterious after all.  But not easy, not at all.  You need to try to invest with the good ones. 

Bottom Line 

A veritable tidal wave of investment dollars is flowing into private equity, and, as with many popular trends (e.g., hedge funds), we believe the results are likely to be pretty disappointing, especially for someone who is the last to the party.  Everyone everywhere can’t beat the market–that math does not work.

Smart long-term investors who follow a consistent strategy of investing with strong private equity managers are more likely to continue to achieve good results, especially if they are smaller investors investing in parts of the market that offer higher returns.

Many large investors will probably see a reduction in their returns as waves of new money flow into these investments and drive deal prices higher.  We may also see a substantial volume of retail sales to accredited investors and perhaps to the general public of the most expensive and mediocre private equity available, the deals no one else wants, sold with extra fees and commissions.

Private equity clearly has a substantial place in the global investment landscape and will likely continue to offer returns commensurate with risk and illiquidity if done well.

Ready to explore the world of private equity? Our experienced private equity financial advisors can help you navigate this complex investment landscape in pursuit of your financial goals.

Team Hewins, LLC(“Team Hewins”) is an SEC-registered investment adviser; however, such registration does not imply a certain level of skill or training, and no inference to the contrary should be made. We provide this information with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in any of the aforementioned areas. Certain information provided herein is based on third-party sources, which information, although believed to be accurate, has not been independently verified by Team Hewins. Team Hewins assumes no liability for errors and omissions in the information contained herein. Certain information contained herein constitutes forward-looking statements. Team Hewins does not guarantee the achievement of long-term goals in the portfolio review process. Past performance is no guarantee of future results, and a diversified portfolio does not guarantee a positive outcome. Nothing contained herein may be relied upon as a guarantee, promise, assurance, or a representation as to the future.