Private equity, the category of capital investments made into private companies, is an increasingly popular alternative investment option for those looking to diversify their portfolios.

In the first five months of 2021 alone, private equity deal volume rose nearly 22 percent year over year, resulting in more than 2,300 deals.

With a history of consistently higher returns than the public market and a current upward trend, it’s no surprise many individual investors are eager to start investing in the private equity space.

IN PRIVATE EQUITY INVESTMENT, THERE ARE THREE KEY PARTIES.

Before commencing the investment process, it is critical to understand the three parties involved in every private equity transaction and their respective roles:

• Investors on their own

• Firms specializing on private equity

• Companies that will benefit from the investment

Individual investors, often known as retail investors, are persons who have money to invest. These investors invest money in private equity businesses in the expectation of seeing a return on their investment. These people are known as limited partners when a business has invested their cash. Pension funds and institutional investors, in addition to high-net-worth individuals, may serve as limited partners. As a limited partner, you are protected from losing more money than your initial commitment.

Private equity companies, often known as general partners, combine the money of limited partners and make strategic choices about how to spend it. Private equity strategies are classified into three types:

• Venture capital is an investment in a startup at an early stage.
• Growth stock is an investment in the growth of a middle-stage firm.
• Buyouts, in which a mature firm is bought outright with the intention of improving its internal operations.

Private equity companies may specialize in one of these techniques or invest in all three at the same time. Private equity investments have extended time horizons, often no less than 10 years, since the return on investment is dependent on the profitability of a firm. While this might be a disadvantage for some since gains cannot be accessed until the exit event, extended time horizons can give the piece of mind that comes with a passive investment: your money is working for you behind the scenes.

Capital is contributed by investors; corporations pool, distribute, and manage the capital; and enterprises employ the money to produce profits. After a certain period of time, returns are paid out to the firm's management (usually 20% of the overall return) and divided among limited partners depending on the amount they initially deposited.

4 STEPS TO BEGIN INVESTING IN PRIVATE EQUITY

1. Understand Alternative Investment Terms

It is critical to comprehend the vocabulary and area of alternative investments before entering into private equity investing.Alternative investments include anything other than stocks, bonds, and cash. Private equity is one of the several techniques that comprise the asset class of alternative investments.

Explore some of Harvard Business School Online's blog postings on alternatives to learn core knowledge:

• Alternative Investments: What Are They?
• 7 Alternative Investments That Everyone Should Be Aware Of
• Understanding Alternative Investment Time Horizons is one of the three essential skills for success in the alternative investment industry.
• Three Major Types of Private Equity Strategies
• How to Evaluate the Performance of Private Equity

Consider taking the online course Alternative Investments for a thorough grasp of the industry and how to evaluate private equity, real estate, hedge funds, and debt investments.

2. Obtain Accreditation as an Investor

After you've gained a solid understanding of the sector, the next stage is to become an accredited investor. Many investing industries, including private equity, hedge funds, and various forms of real estate, need this certification.

According to the United States Securities and Exchange Commission (SEC), to be deemed an accredited investor, you must either:

Earned more than $200,000 (or $300,000 with a spouse) in the previous two years, with a realistic probability of earning the same in the current year
Have a net worth of more than $1 million, either alone or jointly with a spouse (excluding the value of a principal house).

If you do not fulfill these certification standards, you may still invest in other industries that do not need accreditation. Typically, they are standard assets such as stocks, bonds, and publicly traded real estate.

The SEC requires private equity certification owing to the uncontrolled nature of alternative investing. Because investments are unregulated, private equity companies want a mechanism to be relatively certain that investors will remain financially secure if their investments fail.

Determine whether or not you fit into this group; if so, be prepared to disclose financial documents with the business you want to invest with in order to verify your net worth or income.

3. Find and Hire a Private Equity Firm

The next phase in the investing process is to look for and choose a private equity company. Because the firm's management will deploy your investment funds and control investment choices, it's critical to choose one you can trust.

While many private equity companies invest across strategy and sector, they may also operate at the intersections of niches. Based on your own experience and industry trends, consider your choices. For example, if you're a seasoned tech entrepreneur, you can opt to look into venture capital organizations that specialize in technology.

When investigating a firm's prior investments and the returns it has generated for limited partners in the past, use caution. Most corporations disclose information about the companies in their portfolios as well as their overall investment strategy. Read whatever materials a company gives on its strategy, including corporate social responsibility reports, which may provide information about the firms it invests in and their effect on the environment and community.

Another crucial consideration is a company's minimum investment requirement. Historically, the minimum private equity investment size has been $25 million. However, in order to attract a broader investor base, several corporations have recently deviated from this high barrier. The minimum required varies per company; some demand as little as $25,000. Make this a priority in your research to ensure that your investment is a suitable match for the business you choose.

4. Monitor Industry Progress

After you've chosen a private equity company, validated your credentials, and made your contribution, the business's management will oversee the investment. Although you won't see a return on your investment for years, you may keep an eye on industry trends to evaluate how your investment is progressing. Keep an eye on changes in the sectors of the firms receiving your investment, the private equity area, and the alternative investments industry as a whole.

WHY SHOULD I INVEST IN PRIVATE EQUITY?

Although private equity investments are risky and illiquid, the payout is typically worth the risk and wait. Your investment funds might help spark exponential development for the firm or companies that get it, whether it's an early-stage startup, a middle-stage company ready for the next step, or a mature corporation in need of restructuring for a new start. In the long term, the growth these firms experience as a consequence of your financial commitment might produce significant returns on your investment.

If you want to start investing in private equity or other alternatives, consider taking an online course like Alternative Investments to get the essential basic knowledge and skill set. It may teach you the intricacies of each investment type, various investing methods, how to assess investments, and how to construct a robust, varied portfolio.