Private equity investing is investment in a company that is either privately held or taken private through a buyout and reorganized. Smaller investors have three ways to participate in private equity: They can invest in a startup or private company as a member of the friends and family group. They can also buy stock in a publicly trading private capital firm or buy an exchange-traded fund that invests in private capital firms.
If you know of someone who is trying to start a company, this is a good time to invest if you are a small investor. You can even perform work in exchange for stock in the company; this is called "sweat equity." Most startups get their seed funding from the founders and their friends and family members. These investments can range from a few thousand dollars to hundreds of thousands of dollars depending on the resources available. However, these first investors will have their percentage ownership in the company diluted when an angel investor or venture capital firm steps in.
Private Capital Firms
There are two kinds of private capital firms: Venture capital funds invest in startups with the goal of building them up and either selling them to larger companies or taking them public. Buyout firms, also called corporate raiders, take over existing public and private companies using leveraged buyout strategies. Venture capital firms generally invest in companies that have already launched using seed money from friends and family or angel investors. Corporate raiders sell off the assets and certain divisions of the companies they acquire, raising money this way to pay off the bridge loans that financed the takeovers. After restructuring what is left of the company, they either sell it to a larger company or take it public. A small investor has little chance of becoming involved in either of these types of firms, but many of them are public companies such as KKR & Co. (symbol KKR), Leucadia National Corp. (symbol LUK) and Blackstone Group (symbol BX) -- well-known private equity funds with stocks that trade on the public market.
The U.S. Securities and Exchange Commission is concerned that small investors do not have the experience to evaluate investments in startups and are not financially able to hold these illiquid investments for long enough to see a return. That is why they limit non-accredited private investors to 35 in any one firm, and these non-accredited investors must prove close relationships with the company primarily as relatives of founders or as senior employees. So if you want to invest in private equity and don't have the connections with a promising startup, consider investing in publicly traded private capital firms or buy an ETF, such as PowerShares Global Listed Private Equity ETF (symbol PSP), that holds at least 90 percent of its portfolio in stocks of private-equity companies.
To qualify as an accredited investor, you must show income of $200,000 in each of the two previous years before the investment takes place and have a reasonable expectation of making at least that amount in the future. If you are married, you and your spouse must show combined income of $300,000 annually. If you have net worth exceeding $1 million, not including the value of your home, you also qualify. Some finance professionals can qualify because they are regarded by the Securities and Exchange Commission as being financially savvy enough to make such investments. Angel investors must first qualify as accredited investors if they want to join an angel investment group.
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