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October 12, 2017 at 09:11 AM
The private equity market is bigger than ever, with Preqin pegging global assets under management at an all-time high of $2.49 trillion. And it has historically outperformed other asset classes over the long term — so it’s not surprising that investors are eager to tap into it. But like any other type of investment, private equity opportunities can be risky and must be thoroughly evaluated.
Some private equity investments have a greater chance of boosting an investor’s portfolio performance than others. Silicon Valley continues to flood the market with news stories about venture capital investments in startups and seed capital investments in companies still in the research-and-development stage. However, as new and unproven companies in saturated industries like fintech and biotech, they present investment opportunities which are risky and unlikely to deliver the returns and diversification that investors are pursuing.
To provide greater returns and downside protection for investors interested in adding private equity to their portfolios, advisors should consider steering clients toward investments in growth-stage companies that are already producing income and demonstrate strong growth prospects.
Companies in the first stage of development — R&D — have no profits or consistent cash flow, and can’t be certain that they will even have a product to sell. Firms that have passed the R&D phase and entered startup territory have a product to sell, but lack the infrastructure to mass-produce their product and deliver it to their full customer base.
R&D and startup companies with no or few assets, and no track record of generating income, have a much higher risk of failure than growth-stage companies, and haven’t evolved to the point where they are able to deliver predictable or steady returns to investors.
Jeffry Schneider