If you own U.S. stocks, you are investing in the future of America's business. Shares of U.S. companies, as well as thousands of other companies around the world, are traded publicly on stock exchanges. You can see the share price and how that has changed over time.
With a few clicks you can get additional financial information, such as whether the company pays dividends to its shareholders, and the relationship between the company's stock price and earnings (the P/E ratio) – an indicator frequently used by analysts to gauge whether the company is over-valued or could be a potential bargain.
Because the U.S. Securities and Exchange Commission (SEC) requires publicly traded companies to disclose a great deal of information about their operations, you can learn about the management team, its lines of businesses and major risk factors.
That high degree of transparency helps investors make well-informed decisions about whether or not to buy a company's stock. On a global basis, the emerging and frontier markets like India, Brazil, Vietnam and Peru, have adopted similar disclosure rules for public equities traded on their stock exchanges.
But there are many privately owned companies in the U.S. and other countries that need start-up capital for a new venture or growth capital to invest in new products or services, or expand their operations. They might be at an early stage in their growth or have many years of profitable operations. Other privately held companies in financial distress seek buyout capital so the owners can sell their shares to a turnaround firm in order to salvage what value they can from their business.
Those three strategies – venture, growth and turnaround – offer different risks and potential rewards for accredited investors — that is, those with a net worth of $1 million or more (individually or jointly with a spouse) excluding the value of a primary residence. Because private equity strategies have less regulation, a higher level of manager risk, complex tax structures and delays in tax reporting, they are not suitable for all investors.
Historically, wealthy individuals and institutions like pension funds and life insurance companies have been the primary providers of capital in the private equity market, which didn't see significant growth until the 1980s – unlike the public stock markets which have been in existence for hundreds of years. These investors have deep pockets, diversified asset portfolios, and long-term time horizons – unlike most individual investors. That means they are willing to accept the risks that come with private equity investments in return for a potentially higher return on their money.
There are several reasons for an investor to consider private equities. First of all, these investments are not as liquid as public equities, and therefore can't be sold on a moment's notice. Because that increases the risk to the investor, companies seeking private equity investments know that they have to "sweeten the pot" by raising the prospective returns.
To help investors find those opportunities in a risky market where information is at a premium, many savvy money managers have established private equity firms that evaluate potential businesses to see if adding capital can make a difference. For instance, could a company with $25 million in sales grow to $100 million in five years with adequate capital and a strong management team?
If that investment seems to make sense, the private equity firm might obtain funds from wealthy individuals to acquire the company and embark on a new growth strategy. Again, this is a potentially high-risk strategy that is not suitable for all investors.
To summarize, private equity investing can bring a different set of risks and potential rewards and thereby diversify an accredited investor’s portfolio. Talk with your financial advisor before making a decision to see what types of equities may be most appropriate for your individual situation.
Andrew Menachem, CIMA®, is a Wealth Adviser at The Menachem Group at Morgan Stanley in Aventura. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors. Follow Menachem on Twitter @AMenachemMS.