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While not everyone will be familiar with its workings, the UK private equity industry is undoubtedly big business.

Every year private equity firms (and to a lesser extent investors acting as individuals too) provide thousands of unquoted UK companies with the capital they need to develop; they also help to launch ambitious young start-ups with real potential to generate attractive returns or can buy established companies in whole or part.

How it works

While individuals can make private equity investments alone, private equity also works as another type of collective investment, whereby a group of investors pool their money together for a professional organisation to invest on their behalf, often through a fund vehicle.

Private equity houses exist solely to fund or acquire (in whole or part) unlisted companies. Their partners are tasked with raising funds from high net worth and institutional investors and managing the investments made into the underlying companies so that they generate attractive returns. These profits are then shared by the private equity firm and their clients in accordance with how the investment was structured for each party.

European Union rules governing how investment funds are marketed mean that private equity firms are prevented from promoting their funds to retail investors. As such, they can only really access private equity investments through buying a stake in a Venture Capital Trust or shares in a private equity fund which is publicly listed on a stock market. High net worth individuals and sophisticated investors are far freer to invest in private equity, although the private equity house will have to prove to the regulator that its investors have sufficient wealth, knowledge and experience to invest in the asset class. A real understanding of the risks involved is essential, which is why you should take specialist advice from a private equity expert before making any investment. Your wealth manager is likely to have significant expertise in private equity since it is a highly popular asset class: globally, wealthy individuals put around a tenth of their wealth into private equity investments each year.

Risk and return

Private equity strategies take a variety of forms. Sometimes existing investors in the underlying company are bought out, although a private equity firm will often buy a company outright, with the founder/existing management staying in place, or not, depending on their plans and those of the new owners. Equally, private equity can represent a cash injection which will help a struggling business get back on its feet, or provide vital funds to kick-start the next phase of a firm’s growth.

Importantly, because it can take time for investment capital to bear fruit, prospective private equity investors really need to be thinking on fairly long time horizon, although your adviser may be able to source opportunities which are shorter term. Correspondingly, private equity investments are usually highly illiquid – meaning that your money will be tied up for a set term – so you should never invest money that you may need access to quickly. It generally takes between four and seven years for a private equity investment to play out.

For private equity investors, this alternative asset class can represent “grass roots investing” which directly benefits the domestic economy, so it can be a very popular option for those comfortable with taking on more investment risk and who are interested in helping growing businesses. Indeed, private equity investors often provide funding individually to a business they think has good prospects and then take a keen interest in helping to develop it. These “angel investors” can significantly boost the prospects of businesses by investing their time and expertise in them as well as their funds.

The amounts necessary to make a meaningful investment in a reasonably-sized company means that private equity investors are usually asked to invest large sums. Institutional investors like pension funds are active in the private equity space since investors are often asked to tie up millions of pounds for a number of years; even individuals can be asked for a minimum investment of £10m by the largest private equity houses. Yet there are also lots of opportunities in the hundreds of thousands of pounds range or even less – particularly with companies in their early stages. Your professional adviser will have a deep understanding of the entire investment landscape and will be able to recommend a range of appropriate investment opportunities for your profile and needs.

Buyer beware

Those considering private equity need to understand that it calls for a high level of commitment and a strong stomach: it is a long-term, illiquid area of investment which can carry significantly higher risk than traditional asset classes.

Private equity may also make use of some sophisticated (and riskier) financing structures. Consider, for example, leveraged buyouts, which is where a private equity fund would leverage (i.e. borrow additional funds) against the assets of the business interest it is looking to acquire. While such deals can generate very attractive returns, they can represent far more investment risk than many investors can tolerate. You should always discuss any investment decisions with your financial adviser first, but certainly any that are at the more exotic end of the investment spectrum. It is vital that you understand the risks inherent in each potential investment you consider, but also how each will affect the risk profile of your portfolio as a whole. The wealth managers on the panel cover the full gamut of asset classes. If private equity is of interest to you simply indicate so when you take our short online questionnaire and begin the process of finding your best-matched wealth managers.