Private Equity and Venture Capital: Investing in Private Companies

What Are Private Markets?

Private markets = investing in companies not publicly traded:

• Venture Capital (VC): Early-stage, high-risk startups
• Private Equity (PE): Established companies bought out of public markets or never public
• Growth Equity: Companies between VC and PE stage

Why they exist:

• Companies may not want/need public markets
• Flexibility without public company reporting
• Long-term strategic changes without quarterly pressure
• Different capital needs at different stages

Venture Capital Explained

How VC Works

The process:

1. VC fund raises money from investors (LPs)
2. Fund invests in many startups (20-50+)
3. Most startups fail (return $0)
4. A few succeed big (return 10-100x+)
5. Winners compensate for losers

The math of VC:

A single investment returning 50x can make an entire fund successful.

VC Fund Structure

Limited Partnership:

• General Partners (GPs): VC firm, makes decisions
• Limited Partners (LPs): Investors providing capital

Fund terms:

• 10-12 year fund life
• First 3-5 years: Investing period
• Remaining years: Harvesting/exits
• Capital called over time (not all at once)

Fees:

• Management fee: 2% of committed capital annually
• Carried interest: 20% of profits above hurdle rate
• "2 and 20" structure

VC Returns

Top-tier funds:

• 25-30%+ net IRR historically
• 3-4x+ return multiples
• But access is extremely limited

Median funds:

• 10-15% net IRR
• 1.5-2x return multiples
• Often underperforms public markets after fees

Bottom quartile:

• May lose money
• Often fail to return capital

The dispersion is enormous: Fund selection matters more than in public markets.

Private Equity Explained

How PE Works

The process:

1. PE fund raises capital from LPs
2. Fund acquires established companies
3. Implements operational improvements
4. Uses leverage (debt) to enhance returns
5. Sells companies 3-7 years later

Value creation strategies:

• Operational improvements
• Cost cutting
• Revenue growth
• Multiple expansion (buy low, sell high)
• Debt paydown (leverage benefits)
• Add-on acquisitions

PE Fund Structure

Similar to VC:

• 10-12 year fund life
• 2% management fee
• 20% carried interest
• Capital called as investments made

Key difference from VC:

• More debt (leverage)
• Larger, established companies
• Lower failure rate
• More predictable returns

PE Returns

Top-tier funds:

• 20-25% net IRR
• 2-3x return multiples

Median funds:

• 12-16% net IRR
• 1.5-2x return multiples
• May or may not beat public markets after fees

Important caveat: PE return data is self-reported, hard to verify, and subject to various biases. Actual performance may be lower than reported.

Access: The Core Problem

Who Can Invest?

Traditional PE/VC funds:

• Minimum investment: $1-10 million
• Accredited investor status required
• Often require institutional relationships
• Best funds oversubscribed, closed to new investors

What "accredited investor" means:

• $200k income ($300k joint) for 2+ years, OR
• $1 million net worth (excluding primary residence)

The Quality Access Gap

The best funds don't need your money:

• Established relationships with LPs
• Oversubscribed quickly
• May not accept new investors
• Returns concentrated in top quartile

What's accessible to individuals:

• Lower-tier funds
• Funds of funds (extra layer of fees)
• Newer managers (unproven)
• Crowdfunding platforms

The funds you CAN access may not be the funds worth accessing.

Ways to Access Private Markets

Funds of Funds

What they are:

• Fund that invests in multiple PE/VC funds
• diversification across managers
• Lower minimums (sometimes $100k+)

Drawbacks:

• Extra layer of fees (1% + 10% typical)
• Still need accreditation
• Diluted returns
• Long lockups

Registered Funds

What they are:

• SEC-registered funds investing in private markets
• Available to retail investors
• Lower minimums ($10-25k)
• Some liquidity (quarterly windows)

Examples:

• Hamilton Lane Interval Fund
• Blackstone's BREIT (real estate)
• Various interval funds

Drawbacks:

• Higher fees than traditional PE
• Limited liquidity (quarterly, with restrictions)
• May gate redemptions in stress
• Performance may lag top funds

Crowdfunding Platforms

What they are:

• Direct investment in startups
• Low minimums ($100-1,000+)
• Available to non-accredited (with limits)

Platforms:

• Republic
• Wefunder
• StartEngine
• SeedInvest

Drawbacks:

• Companies here couldn't raise from top VCs
• Very high failure rate
• Extreme illiquidity (years to any exit)
• Adverse selection concerns

Secondary Market

What it is:

• Buying existing stakes in PE/VC funds
• Sometimes access to discounted positions
• Still requires accreditation typically

Platforms:

• EquityZen (pre-IPO shares)
• Forge (pre-IPO shares)
• Various secondary funds

Should You Invest in Private Markets?

Arguments FOR

Potential benefits:

• Access to companies before they're public
• Diversification from public markets
• Top funds have generated strong returns
• Illiquidity premium (compensation for lockup)
• Potential for outsized returns

Arguments AGAINST

Significant challenges:

• High fees (2%+ management, 20% carry)
• Extreme illiquidity (10+ years)
• Access to best funds difficult
• Performance dispersion huge
• Complex and opaque
• May not beat public markets after fees

Who Should Consider Private Markets

Who Should Avoid Private Markets

Private markets are NOT appropriate if you:

• Have less than $500k investable
• May need the money within 10 years
• Only have access to retail-available options
• Don't understand the structures and risks
• Would be relying on these for retirement

The Honest Assessment

PE/VC Returns Are Overstated

Problems with reported returns:

• Self-reported, not audited
• Survivorship bias (failed funds disappear)
• Unrealized investments marked by managers
• IRR can be manipulated
• Fees often understated

Academic research suggests:

• Median PE may not outperform S&P 500 after fees
• VC returns concentrated in small number of funds
• Dispersion means manager selection crucial
• "Average" private markets investor likely underperforms

The Opportunity Cost

Consider the alternative:

Is the complexity worth the uncertain premium?

If You Proceed

Due Diligence Checklist

For any private investment:

• Track record (audited, meaningful length)
• Team experience and stability
• Investment strategy clearly defined
• Fee structure (all fees, including hidden)
• Alignment with your goals
• Exit strategy
• References from current LPs
• Legal review of documents

Sizing Your Allocation

If you invest:

• Start small (5-10% of portfolio maximum)
• Diversify across multiple funds/vintages
• Maintain significant liquid reserves
• Plan for illiquidity to last longer than stated

Realistic Expectations

Expect:

• Long periods of no liquidity or updates
• Capital calls at inconvenient times
• Wide range of outcomes
• Likely lower returns than hoped
• Complexity in tax reporting

The Alternative: Public Market Proxies

Get private market exposure through public markets:

• Publicly traded PE firms (BX, KKR, APO)
• Venture-backed public companies
• Small-cap value funds
• REITs for real estate exposure

Benefits:

• Liquid
• Low fees
• Diversified
• Transparent

Not exactly the same, but captures some return drivers.

The Bottom Line

Private equity and venture capital offer potential access to high-return investments unavailable in public markets—but the reality is more complicated. High fees, extreme illiquidity, the difficulty of accessing top-performing funds, and the risk of underperformance mean private markets are appropriate for only a small subset of investors. If you have significant wealth ($1M+), access to quality funds, and can truly lock up capital for a decade, a small allocation may make sense. For everyone else, simple, low-cost public market index funds will likely produce better risk-adjusted returns with far less complexity and cost. The dream of early investment in the next Amazon is real—but so is the reality of the thousands of failures that never made it.