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Do you know that investing money can open up a world of possibilities for you? There are so many options to choose from, but two major categories that you should definitely consider are private equity and public equity. While both offer the chance to make money, they have some key differences that investors should understand.
This article will explain what private and public equity is, discuss their main benefits and risks, and highlight the key distinctions between these two investment types.
What is private equity?
Private equity is the investments made in private companies, meaning companies that are not publicly listed on a stock exchange. Investors provide money directly to a private company in return for an ownership stake or shares in that business.
Some key features of private equity include:
- Not publicly traded: The companies are not listed on the public stock exchanges like the New York Stock Exchange or NASDAQ. This means the shares cannot be easily bought or sold by the general public.
- Less transparency: Private firms have fewer reporting and disclosure requirements than publicly traded firms. Investors thus need more visibility into financials and operations.
- Illiquid: Investors must wait to quickly sell or liquidate private equity investments since there is yet to be a ready secondary market. Exiting a private equity investment may take months or years.
- Higher risk: Private firms tend to be younger, smaller companies with generally riskier outlooks than large public companies. However, higher risk also brings the potential for greater returns.
Benefits of private equity
Some advantages private equity offers to investors:
- Potential for high returns: Younger private firms can provide greater upside than mature public companies. Returns in private equity have exceeded public market returns over extended periods.
- Diversification: Adding private equity exposure may lower overall risk in an investment portfolio dominated by public equity and fixed income.
- Participating in early growth stages: Backing a small upstart company in the early days offers potentially huge returns later on.
- More control rights: Major shareholders in a private firm often get direct managerial influence and voting rights.
Risks of private equity
While private equity offers an attractive upside, there are also notable downsides for investors:
- Illiquidity risk: Investors commit capital for long lock-up periods, usually 5-7 years. Needs to sell out of a private equity investment early presents a major risk.
- Higher volatility: Startups and private companies see wider performance swings than public firms, adding risk.
- Less transparency: With limited reporting requirements, investors depend heavily on fund managers to provide updates and have far less visibility than public companies.
- Fees: Private equity funds charge fees and carry substantial overhead costs that can corrupt returns quickly.
What is public equity?
Public equity refers to investments made into publicly traded companies listed on stock exchanges. Retail and institutional investors can purchase and sell the stocks, or public equity ownership stakes, of listed companies on the exchanges.
Some features of public equity include:
- Exchange-listed: The companies trade on stock exchanges like BSE and NYSE, which facilitate buying/selling of their stocks.
- Liquid: Investors can quickly buy or sell public equity holdings during exchange trading hours.
- Transparent reporting: Publicly listed firms must follow strict reporting guidelines, allowing investors visibility into financials.
- Typically larger firms: Most major corporations choose to list publicly to access capital from public markets.
Benefits of public equity
Key perks offered by public equity:
- High liquidity: The ability to sell stocks freely and immediately is a major plus.
- Lower risk on average: Due to mature businesses, strict regulations, transparency, and established track records of listed companies.
- Low investment amounts: Individuals can invest modest sums to buy stocks. Private equity investing requires large capital commitments.
- Stronger reporting: Timely and regulated disclosures to exchanges ensure investors get regular financial updates.
- Buybacks & dividends: Public companies frequently return cash directly to shareholders through buybacks and dividends – a key way stocks deliver income.
Risks of public equity
While generally less risky than private equity, public equity has notable downsides, too, including:
- Lower growth potential: Large listed companies have progressed beyond explosive growth and thus offer a slower upside.
- Market volatility: Major indices see frequent fluctuations leading to high day-to-day public equity price changes.
- Speculation risks: Irrational exuberance can inflate stock values beyond reason during projections based on speculation rather than fundamentals.
- Macroeconomics: Global recessions can severely hit public equity returns for extended periods.
Key differences between private and public equity
While both offer ownership stakes to investors, some vital differences between private and public equity exist between private and public equity:
- Listing Status: Private equity is unlisted on exchanges, while public equity is openly traded on exchanges.
- Liquidity: Private equity investments get tied up for years and cannot be exited easily. Public stocks offer immediate liquidity since they trade freely on exchanges.
- Company Stage: Private equity firms tend to invest in new and smaller businesses, while public companies are usually established and mature organisations.
- Volatility: Private equity values show wider fluctuations over time. Publicly traded stocks tend to be less volatile in pricing.
- Regulations: Private firms are subject to little to no regulations, while public companies must adhere to strict operational, financial, and reporting guidelines.
- Growth Prospects: Private equity offers higher revenue and profit growth potential. Public equities growth rates tend to be lower over longer terms.
- Private equity vs public equity returns: Over a long period, private equity investments have provided higher returns than the stock market.
- Private equity vs public equity: Private equity is for big investors who want high profits and are okay with locking up funds for years, whereas public equity is for regular investors who prefer steady returns and easy liquidity and are subject to stricter regulations.
- Size of private equity market vs public: The private equity market remains smaller than the public market, but it has expanded considerably over the last decade.
Conclusion
Private and public equities serve different purposes for investors. New ventures offer a bigger return but lock up money for longer and pose a higher risk. Publicly listed stocks offer solid income and transparency but slower growth. Choose based on risk appetite, returns, and liquidity needs. Combining private and public equity exposure in a diversified portfolio can help benefit from their complementary strengths.
FAQs
The key difference is that private equity refers to investments in private companies not listed on stock exchanges, while public equity refers to investments in publicly traded companies.
Private equity investments are generally riskier than other types of investments because the companies being invested in are often new and untested. However, these higher risks can also lead to potentially higher returns in the long run.
Institutional investors like pensions, endowments, and the ultra-wealthy mainly invest in private equity given the large investable assets they manage and the risk profile involved.
Significantly bigger, around 4 times larger. Public equities make up over 80% of total global equity value, while private equity keeps expanding.
Private equity potentially delivers higher revenue and profit growth over decades-long terms based on younger companies scaling successfully over time.