Private equity (PE) is a method of investing where the investor places capital directly into companies that are not listed on a public exchange. Investing $100,000 into a small, local manufacturing company is just one example of a PE investment. PE is often done in conjunction with or as an alternative to traditional stock and bond investing.
PE offers several advantages compared to more traditional investments. First, the return on investment can be exceptional. We have all heard stories of companies that started in the founder’s garage and grew into mega-businesses. PE can also be a great diversifier for a stock portfolio because privately held companies are not directly affected by stock market volatility. Another appealing aspect of PE investing is its tangibility - you can see and touch the building and the products or services of the company you are investing in and talk directly with the owners and employees.
Given these attributes, you may understand my excitement when I decided to research private equity opportunities on behalf of our clients back in 2012. I envisioned finding interesting opportunities for clients that would add diversification to their portfolios and offer the potential for handsome returns.
After spending two years learning about the industry and reviewing investment opportunities, I was disappointed in my discoveries. In reality, finding successful small companies that warrant investment is like finding the proverbial needle in the haystack. The general ratio used in the PE industry is 10:1 – you need to invest in 10 “deals” to find one outstanding investment. I think the ratio is more like 20:1.
Our own experience serving clients offers further confirmation of how difficult it is to successfully invest in private companies. Over the past 36 years, many clients have come to us with private equity investment holdings in their portfolios. I would estimate that less than 5% of those have turned out well.
Early on, when I was learning about the PE industry, I asked a veteran investor for advice. He chuckled and said, “Don’t do it.” At the time, his statement puzzled me. But over time, I have come to appreciate his advice.
The unfortunate truth is that private equity investing is more like gambling than investing. It is not a prudent way for most people to grow their wealth. That is why PartnersInWealth does not recommend private equity investments for our clients.