The pros and cons of private equity

If you’re willing to invest with patience, private equity funds can be a great tool to diversify your portfolio and generate strong returns. These funds focus on long-term investments in private companies, aiming to unlock value through strategic management and operational improvements. While the rewards can be significant, private equity also carries unique risks that you should understand before deciding to invest.

Private equity funds are investment vehicles that pool capital from institutional and accredited investors to invest directly in private companies or acquire public companies with the intention of taking them private. They often focus on operational improvements to boost the value of the companies they invest in. These funds are closed-end investment vehicles, meaning the amount of investment capital is fixed from the start.

Private equity funds typically have long lockup periods, which can last seven to 10 years. During this time, you are not allowed to withdraw your money. A longer-term focus means private equity investments require patience.

Private equity funds typically make money through leveraged buyouts or growth capital investments. A leveraged buyout involves buying a company using borrowed money, putting the company’s assets up as collateral and eventually selling the company at a profit. Growth capital involves providing funding to swiftly growing businesses, usually while taking a minority stake in the company.

You can evaluate private equity firms based on their historical returns. Also, consider common metrics for success, such as the internal rate of return (IRR) and multiple on invested capital (MOIC).

Private equity funds offer the potential for high returns, especially if you have a long-term outlook and a tolerance for illiquidity. However, they do come with risks, including company-specific failures, leverage-related losses and limited transparency. Market timing and manager skill are also critical variables.

To manage risk, private equity firms conduct extensive due diligence, often take active roles in company management and diversify across industries or geographies. Still, returns can vary widely based on the manager’s strategy, expertise and market conditions.

Private equity can play a valuable role in your portfolio, offering access to exclusive opportunities and long-term growth. A trusted financial advisor can help assess your risk tolerance, liquidity needs and investment goals to determine whether private equity is the right fit for your financial plan.