Keeping Your Business Private
Should You Invest In Private Firms?
Let me ask you something: if I asked you to name three companies, which ones would pop into your head? Chances are, your first thoughts wouldn’t be “The Golden Croissant,” that charming bakery around the corner (and no, this isn’t a paid promo for their buttery perfection). You’d probably think of giants like Apple, Microsoft, or Nvidia – the titans that rake in billions and dominate headlines.
Here’s a fun fact for you: there are about 359 million companies worldwide, according to Statista. And get this – a whopping 90% of them are SMEs, or Small and Medium Enterprises. That’s your local coffee shop, your favorite indie brand, or the startup you’ve been secretly rooting for. Compare that to the U.S., where there are only a few thousand publicly traded companies. When you think about it, most businesses are private – hidden away from the reach of small investors like you and me. Or… are they?
Yep, that’s exactly what this article is about. Today, I’m going to guide you through the wild, sometimes confusing world of investing in private companies. Here’s what we’ll cover: first, we’ll break down the key differences between public and private firms. Next, I’ll show you how to get your foot in the door and invest in private companies. And finally, we’ll tackle the big question: “Are private firms really worth your money?”
Ready? Let’s get started!
Unlocking the World of Private Equity
We’ve already concluded that private companies outnumber public ones by a significant margin. What may surprise you, though, is that investing in private firms isn’t entirely out of reach. While most private equity (PE) opportunities are reserved for high-net-worth individuals, there are ways to dip your toes into this lucrative—and often mysterious—market. Let’s explore the two main investment vehicles in private equity and how you might participate.
Private Equity (PE) Funds: The Powerhouses of Mature Firms
PE Funds are the giants of private equity. These funds focus on acquiring established, cash-generating private firms. Managed by one or more General Partners (GPs), their job is twofold:
Find and invest in private firms, typically mature businesses with stable cash flows.
Monitor performance and plan an exit strategy, which is a carefully timed sale of the investment to maximize returns.
The exit price is often determined using a multiple of earnings. For example, if a bakery like "The Golden Croissant" earns $1M annually and has a valuation multiple of 5x, the business could sell for $5M. Of course, this valuation depends on factors like market sentiment and negotiation power.
These funds also rely on Limited Partners (LPs) to provide the capital. LPs are often ultra-wealthy individuals, with minimum investments that can run into millions of dollars. But there’s a downside for LPs: the money is typically locked up for years, and funds operate with a fee-heavy structure. The infamous "2/20" fee model means GPs take 2% of the invested capital annually and 20% of the profits—making it a lucrative field for fund managers.
The biggest drawback? Illiquidity. As an LP, you’re committed for the long haul, often 7–10 years, with no easy way to cash out mid-cycle.
Venture Capital (VC): Betting on the Future
If PE is about established businesses, VC is about potential. Venture Capital funds focus on startups, searching for the next big thing in a landscape of unproven ideas. While this makes VC riskier than PE, the rewards can be much higher. Think of early investors in companies like Airbnb or Uber—they hit the jackpot, but many other startups fail to take off.
The structure of VC funds is similar to PE, with GPs and LPs playing their respective roles. However, VC funds typically acquire smaller stakes in companies, as they invest less capital upfront. This smaller equity share reflects both the risk and the need for founders to retain control.
Interestingly, not all VC investors are in it for the money. Some wealthy individuals enjoy the social clout of backing the next “hot” startup. Others genuinely believe in supporting innovation and change.
Can You Invest in Private Equity?
For most of us, traditional PE and VC funds are out of reach. The barriers to entry—high minimum investments, long lock-up periods, and lack of liquidity—make these funds exclusive to the wealthy. However, there are alternatives.
Funds of Funds: These invest in a mix of PE and VC funds, offering a diversified way to access private equity.
Private Equity ETFs: Publicly traded ETFs like the iShares Listed Private Equity UCITS ETF (not investment advice) track the performance of private equity funds.
These options come with their own risks. Private equity investments are less transparent, making it harder to respond to market shifts. Smaller firms, typical of private equity portfolios, tend to carry higher risk profiles. However, these vehicles can make private equity accessible to everyday investors looking to diversify their portfolio.
Private equity is a world of high stakes and potentially high rewards, but it’s not for the faint of heart. While the exclusivity and illiquidity of PE and VC funds can be daunting, alternative investment vehicles are opening doors for curious investors.
In the last part of this article, we’ll examine the historical performance of PE funds to determine if this high-stakes game truly delivers on its promises.
Should You Keep Your Money Public?
So here we are, standing at the (multi)million dollar question: “Should you invest in Private Equity?” As with most things in life, the answer isn’t a simple yes or no. If we look at the numbers, private equity (PE) investments have consistently outperformed public markets across the board. On average, PE delivers 2–4% more annually than public benchmarks. Over a decade, that adds up to a staggering 20–50% extra return, depending on how the comparison is made and which dataset (proprietary or public) you’re using. Sounds like a slam dunk, right? “Yes, invest!” – case closed.
Not so fast. There’s a catch—or rather, two big ones. Let’s unpack them.
First, remember those pesky fees we talked about earlier? The performance numbers I just mentioned are gross-of-fees, meaning they don’t yet account for the hefty deductions that private equity managers take. With the standard “2 and 20” fee structure (2% of capital invested plus 20% of profits), a significant chunk of those juicy gross returns never makes it into your pocket. What looks great on paper can lose its luster when the fees are factored in.
Second, let’s talk risk—the ever-present shadow in every financial decision. The risk-return tradeoff is straightforward: riskier investments demand higher compensation in the form of returns. In PE, the risk story revolves around three key players:
Liquidity risk: Your money is tied up for years. Once you’re in, it’s not easy—or cheap—to get out unless you find someone to buy your position.
Systematic risk (beta): Beta measures how much an investment moves with the broader market. PE investments typically have a beta above 1, meaning they’re more volatile than the market. More risk = more potential return.
Idiosyncratic risk: This is about the specific risk of individual firms. With PE focusing on smaller or early-stage companies (especially in venture capital), idiosyncratic risk is high, and so are the expected returns.
So yes, gross performance in PE often beats public markets. But when fees and risk-adjustments come into play, that outperformance shrinks—and sometimes disappears.
Still, there’s a wildcard: the General Manager (GM)—the person steering the PE fund. A skilled GM can make all the difference, driving value through operational improvements, strategic advice, and stronger governance in portfolio companies. Research shows these efforts are a big reason private companies under PE often excel. A truly top-notch GM might even push net-of-fees returns past public markets, making PE a compelling investment despite the hurdles.
Concluding Remarks
I hope I’ve done a decent job—at least a passable one—of breaking down what private equity (PE) is, how you might dip your toes into it, and whether it’s the right fit for you. Let’s be real: PE is a tough, opaque world, and that’s precisely why I personally choose not to invest in it. As Warren Buffett famously said, “Invest in what you understand.” For me, that’s the golden rule—not just for PE, but for any investment. Taking the time to educate yourself and do thorough due diligence is absolutely essential.
That said, after digging deep and doing the homework, I do think PE can be a fascinating way to diversify. And no, not to mask a lack of understanding (as we’ve covered here), but because it’s an asset class with characteristics that stand apart from traditional ones you might already hold. Its potential for diversification lies in its differences—offering unique opportunities for those who know how to navigate its risks.
At the end of the day, private equity isn’t a universal solution. But with the right manager, a solid grasp of its risks, and a clear-eyed look at the fees, PE could very well be the opportunity that gives your portfolio an edge.
References
Ellis, C., Pattni, S., & Tailor, D. (2012). Measuring private equity returns and benchmarking against public markets. SSRN Electronic Journal. https://www.bvca.co.uk/Portals/0/library/Files/News/2012/2012_0007_measuring_pe_returns.pdf
Korteweg, Arthur G., Risk and Return in Private Equity (August 3, 2022). Handbook of the Economics of Corporate Finance, Vol 1: Private Equity and Entrepreneurial Finance, Forthcoming , Available at SSRN: https://ssrn.com/abstract=4170135