The private equity market is one of the highest-growth asset classes of the last decade. Disruptive technology firms, which are driving both of the growth in global equity value, are staying private for longer. This means more of the extreme returns are accruing to private equity funds and venture capitalists rather than retail stock market investors.
In this article, we explain how to invest in private equity, and point out the high risks of doing so.
- Investing in small companies carries a high degree of risk as small companies experience a much higher failure rate than established business quoted on a stock exchange
- Private markets are by definition illiquid and you may be tied in to an investment indefinitely
- The returns from private equity, venture capital, EIS and angel investing investments are highly volatile and can occasionally exceed 50% (+/-) in a single year.
- Many private equity investments are not suitable for everyday investors will only be accessible an investor meets the definition of sophisticated investor or institutional investor.
- This article is based upon journalist research and does not replace financial advice. The UK financial regulator suggests that investors consult with an independent adviser prior to making high risk investments.
Who can invest in private equity
Private market investments are high risk and subject to less regulation by the Financial Conduct Authority. Consequently, certain private equity financial promotions are restricted to sophisticated investors. You can read our sophisticated investor definition to see if you meet the criteria.
Some of the options below such as using a financial adviser, investing in listed private equity firms quoted on the stock exchange, and using an online crowdfunding platform are available to retail investors.
How to invest in private equity
In this article, we set out how to invest in private equity through two routes, and the different practical options available along each.
The first question is whether you want to invest in a collective private equity fund, or take a DIY approach to invest in the equity of small & high growth companies.
Collective investments provide a hands-off experience and provide some peace of mind in the sense that your investments will be managed by a full-time team of financial professionals.
As a DIY private equity investor, you’ll have to screen investment opportunities and perform due diligence yourself. You’ll have complete control over the size and composition of your private equity portfolio.
There are advantages and drawbacks to each approach, which we’ll outline in each section.
How to invest in collective private equity funds:
A UK investor has four main options to participate in private equity through collective investment.
- Via your financial adviser or wealth manager
- Private markets platform
- Venture Capital Trusts
- Listed private equity firm
Via your financial adviser or wealth manager
Most private equity investments (by value) will be advised, which means they were made under the guidance or direction of a professional financial planner, adviser or wealth manager.
Not all financial advisers will have experience in private market investments, therefore it’s important that your advice firm or private bank is well accustomed to these exclusive investments.
Financial advisers will perform a limited degree of due diligence on a fund and crucially they will examine whether a private equity investment fits with your broader investment portfolio and financial goals. Too many investors are drawn into private equity thanks to headlines about financial returns and are ill-equipped for the risk and lack of liquidity that is inherent to this asset class. Advised clients are less likely to make this mistake.
Your financial adviser will be able to apply to subscribe to a private equity fund through their network and institutional connections. Only a portion of live private equity funds are open to new investment at any one time.
Private markets platforms
Private markets platforms perform a similar role to the financial adviser above, but on a non-advised, execution-only basis. In effect, they facilitate the placing of your investment and will charge an initial fee which is usually calculated as a % of your subscribed amount.
In simple terms, a private market platform is a gatekeeper who can introduce you to an investment opportunity.
Private markets platforms allow investors to browse investment opportunities, making them an excellent place to start when researching the market. A typical platform will promote between 5 – 15 funds that are currently seeking capital.
Examples of private markets platforms include:
Wealth Club – www.wealthclub.co.uk
Private markets platforms are typically only open for sophisticated or high net worth investors.
Venture Capital Trusts (VCTs)
Venture Capital Trusts are a UK-variant of private equity fund that come with generous tax breaks that could provide a reduction in your income tax liability (subject to your personal tax circumstances).
Our VCT explanation will help you understand the various features of a venture capital trust. The headline relief is a reduction in income tax equivalent to 30% of the investment sum, but strict conditions must be met in order to receive this relief.
The number of ways to invest in VCTs has expanded in recent years. Some of the best VCTs can be subscribed via a financial adviser, private markets platform but some VCT providers invite investment directly via their website.
For example; VCT provider Octopus Investments accepts subscriptions directly from investors with a minimum investment of £1,000.
Listed private equity
Listed private isn’t technically a collective investment but you will soon understand why this opportunity to gain exposure to private equity is included in this first group of strategies.
This option involves buying the quoted shares of the best listed private equity firms on the stock market.
That’s right – several private equity firms floated on the stock exchange years ago, meaning that public shareholders now receive the financial returns of the firm rather than just a group of private equity partners.
A private equity firm generates income from a number of fees it charges the funds under its management. These include periodic management fees and performance fees which are deducted from the profits generated by investments.
At the peak of the private equity cycle, earnings will be high, but performance fees can evaporate when financial markets enter a slump.
By owning shares in private equity firms, you will enjoy the diversification effect of receiving a financial return linked to the performance of a group of funds, rather than a single fund. However, due to the lower risk, the expected returns of this strategy will be significantly lower than a direct investment in a private equity fund. Unfortunately, the capital markets offer no free lunches.
How to invest in equity of private companies
Adventurous UK investors with a high-risk appetite can access the opportunity to directly invest in small companies through these two main routes:
- Angel investing syndicate
- Equity crowdfunding platforms
The probability of a single start-up firm failing within five years is relatively high. As such, some DIY private equity investors adopt a very different mindset around their private investments compared to their investment portfolio.
They prefer to think of their subscriptions as an expense rather than an asset, (to use terminology straight from an accounting book). What this means is they view their private equity outflows as a sunk cost – money that has been spent for good reason, but is now effectively out of the picture.
In layman’s terms, they see it as buying a lottery ticket compared to making a deposit in a bank.
This way, if a firm fails, it’s no big deal. This was already money that the investor had budgeted and spent on the chance of striking it lucky. Any successes are an upside!
Of course, this mindset doesn’t actually increase returns. But it helps investors frame the DIY private equity experience more positively. With many failures being almost guaranteed in any large private equity portfolio, a strong mindset is needed to succeed.
Angel investing syndicate
An angel investing syndicate is a group of like-minded private equity investors who source and complete deals to invest in small businesses as a group to reduce the cost of investment.
Completing due diligence and retaining the legal advisers needed to conclude deal after deal is a terrifically expensive process. Angel investors who club together and share this overhead as a group of 10 – 50 individuals will slash their transaction costs.
Angel investments may qualify for tax relief in the shape of the Enterprise Investment Scheme (EIS). Read our guide to EIS to understand more about how angel investors reduce the net cost of their investment by up to 25%.
Our article how to become an angel investor explains more about angel syndicates.
Equity crowdfunding platforms
Equity crowdfunding platforms didn’t exist ten years ago. They are recent emergence in the UK online space. Crowdfunding platforms have democratised the private equity world and increased access to retail investors.
In our Funderbeam review, we point out that a crowdfunding platform can allow retail investors to invest like a business angel with transaction costs as low as 1.5%.
The platform displays each live opportunity, together with the business case, financial projections and updates from the company executives. Investors can subscribe with low minimum sums (e.g. £100), allowing them to spread their risk across a large number of companies with relatively little money.
When we ranked the best equity crowdfunding platforms, we were blown away by the innovation taking place on some of the UK platforms.
Both Seedrs and Funderbeam have developed secondary markets where investors can buy and sell shares in companies that had previously completed fundraisings on the platform. This provides the prospect (although no guarantee) that investors can ‘exit’ their investments without waiting for the company to be acquired or list via an IPO.
Conclusion: how to invest in private equity
To invest in private equity, you must first choose whether you want to pick the companies yourself or subscribe to a collective investment where deals are separately chosen and negotiated by a fund manager.
The best private equity books could help you make this choice by sharing stories about the experiences of those who have worked on both sides of this coin.
The options available to sophisticated and retail investors have exploded in the last 10 years, so you have more choice than ever when finding your route to private equity returns.
This increased access has done little to reduce the very high risk of private equity investments, therefore it’s still most sensible to approach this asset class through a financial adviser.