Key takeaways
- Private equity refers to ownership in a private company, often done through private equity funds that cater to high-net-worth investors.
- Public equity refers to ownership in publicly traded companies, which are available to anyone with an investment account.
- Private equity has historically higher returns but isn’t available to everyone and has downsides that include higher risk, higher fees, and lower liquidity.
What is private equity?
Private equity refers to an investment in a private company. Private equity is a common source of funding for private companies, meaning those that aren’t publicly traded. High-net-worth individuals may choose to provide funding to companies. In return, those investors get a share of ownership — and, therefore, profits — of the company.
Those who invest in private equity do so because they hope to earn higher returns than they can from public equity investments.
What qualifies as private equity?
Private equity consists of any equity investment in a non-publicly traded company. In most cases, private equity refers to private equity funds. These funds pool the money of many individuals and then invest it in private companies.1
Private equity funds often focus on long-term investments. For example, a private equity fund might invest in a startup and not expect to get their money back for upwards of 10 years. Additionally, private equity generally has high investment minimums. For example, a private equity fund made up of high-net-worth investors might require an investment in the hundreds of thousands — or even millions — of dollars.
There are a few different strategies that private equity funds take. First, some aim to purchase a controlling interest in a startup (known as a portfolio company) and play an active role in its management. On the other hand, some private equity funds take a minority position, acting as silent partners.
It’s worth noting that private equity funds are generally only open to accredited investors,2 which could be:
- An individual with an income of at least $200,000 (or $300,000 when combined with a spouse)
- An individual with a net worth of at least $1 million, either together or when combined with a spouse
- An individual with a Series 7, 65, or 82 license in good standing
- A trust with assets of more than $5 million
- An entity with total investments of more than $5 million
- An entity where all equity owners are accredited investors
Can a private equity firm go public?
When a company goes public, it issues an initial public offering (IPO) to offer shares to the public for the first time. Companies previously funded by private equity can go public. In fact, many companies that go public were first funded by private equity.
When a private company goes public, existing shareholders maintain equity in the firm. Their private shares convert to public shares, and their value is determined by the public trading price. In some cases, private investors may be subject to lock-up periods, which prevent them from selling their shares during or immediately after an IPO, but that’s not always the case.
It’s also worth noting that when a company goes public, existing shareholders may see their ownership diluted. For example, a private equity firm that owned 10% of the firm may own just 5% after an IPO because of the additional shares the company issued.
Does private equity outperform public equity?
There’s a reason wealthy people often have private equity in their portfolios: high returns. Data from Cambridge Associates shows that private equity has consistently outperformed stocks for the past 25 years. Their comparison is between the returns of roughly 1,500 private equity funds and the Russell 3000, which is an index made up of the 3,000 largest U.S. public companies.
During the 25-year period ending with December 31, 2022, private equity saw an average annual return of 13.33%, while the Russell 3000 saw an average return of 8.16%.3
But those returns don’t necessarily tell the whole story. First, private equity is considered a high-risk investment. Yes, you have a chance of getting a return that’s higher than the stock market. However, you also have a greater chance of losing your money, given that private equity often invests in startups. Private equity funds also tend to have high fees, which can cut into returns.1
Additionally, private equity funds are highly illiquid. When you invest in one of these funds, you’re often committing your money for many years before you can expect a return. As a result, you’re faced with the opportunity cost of the investment returns you could have made elsewhere during that time.
What is public equity?
Public equity refers to equity (aka ownership) in publicly traded companies that are listed on stock exchanges such as the New York Stock Exchange and the Nasdaq.
There are some key differences between public equity and private equity, the most notable being who is able to invest. As mentioned, only accredited investors and institutional investors can invest in private equity. On the other hand, anyone can invest in public equity.
It’s easy to open a brokerage account and buy shares different companies. In fact, many people invest in public equity without knowing it. If you have a 401(k) through your employer, you almost certainly have public equity investments.
There are several ways to invest in public equity. First, you can buy shares in individual companies. For example, you can buy a single share of stock in Apple. In addition to the potential capital gains and dividends you can earn, you also become a partial owner of the company.
Another way to invest in public equity is through mutual funds and exchange-traded funds (ETFs). These pooled investments allow people to add hundreds or thousands of companies to their portfolios with just one investment.
Other characteristics of public equity include:
- Higher liquidity: You can buy and sell public shares at any time, making it easy to turn your equity investments into cash with little notice. Compare that with private equity, which can have time horizons of a decade.
- More oversight: Public companies are subject to regulation by the Securities and Exchange Commission (SEC), including requirements to file financial reports and other documents on a regular basis.
- Lower risk: Public companies and public equity investments generally present a lower risk to investors, especially when you invest in a well-diversified portfolio including mutual funds or ETFs. Compare that with the high risk of private equity investments.
- Lower fees: Public equity investments have considerably lower fees than private equity. You may be subject to trading fees when you buy (though these are becoming less common). And if you invest in funds, you’ll pay an annual expense ratio.
What is an example of public equity?
As we mentioned, a public equity example that applies to many people is the assets in your 401(k). When you put money into your company’s retirement plan, you’re able to choose from a variety of investments which typically includes mutual funds. Many people choose to invest in target-date funds, which are diversified portfolios appropriate for your retirement time horizon.
Within your funds will be hundreds — or even thousands — of individual investments, including public equity investments. For example, you might own shares of a total stock market index fund in your retirement account. That means you have a small share of equity in many public companies in the U.S. stock market.
Can a public equity firm go private?
Just like private firms can go public, public firms can also become private again. When a company is taken private, an investor — often a private equity firm or a group of private equity firms — purchases the company’s public stock, often using outside financing. The company is delisted from stock exchanges, and shares are no longer available for purchase.
One of the reasons a company might decide to go private is to avoid the time and financial commitment required to comply with federal regulations imposed on public companies.
Privatization can also be beneficial for a struggling company that wants to make major operational changes. They may take the company private only temporarily, with the goal of going private again when things turn around.
Read more: Why do public companies go private?
How to maximize your income
Both private and public equity may help investors make money, whether it be as a passive income today or to help prepare for retirement.
One of the most important tenets of investing is diversification. In other words, don’t put all your eggs in one basket. Whether you’re investing in private or public equity (or both), it’s important to have many different assets in your portfolio.
When you’re investing in public equity, diversification is easy to accomplish. You can invest in an index mutual fund or ETF and immediately have an interest in hundreds or thousands of public companies in your portfolio. If you’re investing in private equity, it’s just as important to consider diversification. Private equity is considered an alternative asset, meaning it’s not suggested to make it the only asset in your portfolio.
Another way to help maximize your investment income, at least for public equity investors, is to use a tax-advantaged retirement account, such as a 401(k) or an individual retirement account (IRA). Because you don’t pay taxes on your investment growth, your money has the opportunity to grow more than if you invest in a taxable brokerage account.
Special considerations
For many people, the decision of whether to invest in private or public equity is made for them. As mentioned, private equity is only available to accredited investors and institutional investors, which excludes most people.
If you are an accredited investor, weigh the pros and cons of private equity to decide if it’s right for you. Remember that higher potential returns are paired with higher risk, lower liquidity, and higher investment fees.
The bottom line
Private equity and public equity can both have a place in a well-diversified investment portfolio. However, it’s important to understand the features, pros, and cons of each option. And if you aren’t yet an accredited investor but want to invest in private equity, you can use that as your motivation to grow your portfolio more quickly to reach the $1 million threshold needed.
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1 Investor.gov, “Private Equity Funds.”
2 Investor.gov, “Accredited Investors – Updated Investor Bulletin,” April 2021.
3 Cambridge Associates, “US Private Equity,” December 2022.
