Private equity can give an investor increased capital and the chance to diversify through various management groups, but it isn’t all good. There are significant disadvantages to investing in private equity. These are the main pros and cons someone should consider before spending money.
Pros of Private Equity Investments
- High Returns: Private equity is a multi-billion-dollar business and is so large it can affect the whole economy with the buy and sell of companies all over the world. This investment style has the potential to create millions of dollars in returns with the purchase of a distressed business for the purpose to sell it later when it’s created high profit.
- New Opportunities: There are over 27 million companies in the United States, and less than 1% of these companies are traded on public markets. Private equity gives you a new opportunity to invest in businesses that were otherwise inaccessible. Additionally, public companies can have their stock affected if the latest news shows a decrease in sales. Private companies don’t have to report their sales, which keeps their stocks much more steady.
- Active Investment: Investing in stocks or public markets are passive whereas private equity management has an active investment strategy. It requires the acquisition of a distressed company, the improvement of financials, and the sale of the business for profit. This means investors have a direct link to influence the company to direct it in the proper direction for increased capital growth.
- Diversification: Just like hedge funds, private equity allows for a certain amount of diversification for an investor’s portfolio. Businesses are divided into sectors, and some private equity funds use a fund-of-funds approach that allows for an investor to participate in many accounts at once.
Cons of Private Equity Investments
- Long Turnover: Private equity investments are a long-term investment with long turnovers. The average amount of time an investment is left to capitalize is around 5.5 years. Shorter hold times are possible but are usually driven by a booming exit market. Typically, an investment will remain in growth for three to five years.
- Debt: Private equity can be risky for the potential investor because of the amount of debt used to purchase investments. If the leverage is called, it could cause the collapse of the fund and the acquired business, which can result in massive losses for all other investors. Most distressed companies also come with a certain amount of debt when purchased, as well. This only increases the amount of risk for each investor.
- Transparency: Private equity markets have lower regulation when compared to the stock exchange and some claim that there are controversial tactics still in practice, such as a fee-waiver tax practice that was investigated in 2012. The investigation claimed that a greater amount of an investor’s capital directed away from higher-taxed fees and into a category that is taxed more favorably. Investors rely on the private equity firm to manage the investment, but not every group can be trusted.