Private Markets Explained: Definition, How They Work, How to Invest
What Are Private Markets?
Private markets, also known as private capital markets, are investment opportunities that exist outside of public stock and bond exchanges. They include investments such as private equity, private credit or debt, venture capital, and real assets such as infrastructure, commodities, and real estate.
Private markets help both startup and established companies get off the ground or grow by raising necessary capital directly without the regulatory and disclosure requirements of being publicly listed. Investors provide capital with the expectation of long-term returns, which are typically realized through company exits, interest payments, or asset appreciation. This type of investment has grown in popularity recently as investors have an opportunity to achieve a potentially higher return when compared with the public market.
Key Takeaways
- Private markets offer access to alternative investments not available on public exchanges.
- These investments can provide higher returns but often involve greater risk and illiquidity.
- Diversification benefits may be gained by adding private assets to traditional portfolios.
How Private Markets Work
In private markets, capital is typically raised through private placements rather than public offerings. Investors commit money to funds or deals that are managed by professional investment firms.
Capital is invested into targeted private assets, such as buyouts of privately held businesses or loans to startups or established companies. These investments are tradable on the open market and are usually illiquid.
Returns are generally realized over several years through events like companies being acquired, interest payments on loans, or the appreciation of real assets. However, private market investments also constitute higher risk.
Fast Fact
Private markets are projected to reach more than $18 trillion worldwide by 2027.
Types of Private Market Assets
- Private equity: A subset of private markets, private equity refers to investments from multiple investors in well-established companies through private equity firms. The idea is to purchase a stake or all of a private company, increase its value, and then exit at a profit.
- Venture capital (VC): These types of firms fund and mentor startups in exchange for equity in the company. If the company either goes public or gets acquired, the VC firm makes a profit. VC investments usually constitute high risk, but can also yield a high reward.
- Private debt: Refers to the purchase and sale of debt securities and loans of private companies. Often also referred to as private credit, several forms of private debt include direct financing by lenders, mezzanine debt, distressed debt, private debt funds, and venture debt. Investors should see a stream of income as businesses begin to pay back their loans.
- Real assets: Refers to investing in the purchase of physical assets through private funds. These may include infrastructure, commodities, and real estate. Generally, real assets tend not to be as volatile as investments such as stocks.
Example of Private Market Investment Mix
Here’s a sample diversified portfolio:
- 30% private equity
- 20% private debt (private credit)
- 15% venture capital
- 15% real assets
- 20% public market stocks and bonds
This diversified private market investment mix balances growth potential, income generation, and mitigates financial risk. The 30% in private equity and 15% in venture capital target long-term capital appreciation, coupled with potential for significant financial gains, while the 20% in private debt provides steady income. Fifteen percent in real assets offers stability and long-term returns, and keeping 20% in public market stocks and bonds can ensure a certain amount of liquidity and broader market exposure to mitigate risk.
Advantages and Disadvantages of Private Markets
Pros
- Potential for greater return when compared with the public market.
- Access to investment opportunities is not usually available to the general public.
- Investors may have the opportunity to directly participate in the growth and success of a business.
Cons
- Less information is available to investors regarding a company’s financial performance, unlike public companies.
- Not subject to the same disclosures as public companies, which could result in less transparency and an unclear timeline as to when an investor will see financial returns.
- Higher fees and investment minimums compared with the public market
- Illiquidity
Tip
Carefully review the terms of a private investment before committing your capital, since fee structures may significantly eat into your financial returns.
How To Invest in Private Markets
Private market investors can gain exposure through private equity firms, venture capital firms, through the purchase and sale of private debt, and investments in real assets such as real estate. These types of investments are often available through funds managed by specialized financial firms, and access is limited to accredited or institutional investors who have significant amounts of capital.
What Are Private Market Investments?
They are investments in assets that are not traded on public exchanges, such as private equity, real estate, or private debt.
Who Can Invest in Private Markets?
Generally, only accredited and institutional investors can invest in private markets. These types of investments aren’t usually available to the general public.
What Are the Risks of Private Markets?
Risks may include illiquidity, limited disclosure, and the possibility of total loss on certain investments.
How Are Private Markets Different From Public Markets?
Private markets focus on investments not traded on the public market, which are less regulated, less liquid, and are usually only available to accredited and institutional investors. In contrast, public market investments like stocks are accessible to the general public, are more regulated, and offer more liquidity.
The Bottom Line
Private markets offer portfolio diversification by investing in private companies. While these types of investments are riskier and offer less liquidity and transparency than public markets, there’s also an opportunity for higher returns. If you’re an accredited investor with access to private market investments, understanding all the types of investments available and how they work is crucial before putting up significant capital.