Should You INVEST In Private Equity?

Hey, hey, welcome back to the show. Today we're going to talk about, should I invest into private equity? We're going to walk through from the investor point of view what it's like to invest into a private equity fund, what kind of terms and rates you can expect. We're actually going to walk through some of the most exclusive funds on the planet that you need sometimes a $50 or $100 million check to even get into those funds. It should be a pretty fun episode. I'm excited to dive into this. Now, recently on the comment section, I've seen you guys been hassling me about my floating shoe that I had in my— and we have a couple studios we film out of. We have a floating shoe in one of our studios that floats and spins, and you guys saying, I feel like I'm gonna have anxiety from this. I can't watch your video because it's spinning so much. So because of that, we're in this studio. We usually don't have this shoe in here, but just to, just to tool everybody that was on there. I actually brought the shoe spinning with us today, so we're actually gonna set this puppy up just for all you haters out there that don't like the shoe. And boom, baby, there she is. I just set it up on a nice little slow rotisserie spin over there. Now people wonder why we have this in our background. We do this shoe beat in our community. We give this out as an award to people who raise over $10 million inside of their fund. They get one of these shoes. We've actually sent out, I think it's around 6 or 7, 8 shoes now in the last 6 months that people have done it. It's been incredible to see people launch scale funds. It's been awesome. So that's why we got it in the background, and it's gonna stay for the video. So if you have anxiety from it, I'm sorry, look over here, whatever's gonna go on. All right, so back to the topic. Now first, we gotta identify what actually is private equity. A lot of people throw this term around for a lot of things, but let me give you a base overview of what these are in relation to a hedge fund, venture capital fund, real estate fund. All of these types of funds are actually structured pretty much the same. Most of them use a limited partnership, or fund is what they'll call it, and investors, or limited partners, Will write checks that we're going to talk about today. They are going to invest— limited partners— into the limited partnership. So up here, these are your investors, and then they, as the fund managers, are over here in a separate entity called the general partner. You guys with me so far? You following along? Okay, so you got limited partners that have money— investors— they put the money into a limited partnership. A general partner or fund manager will oversee what goes on inside the limited partnership. And that general partner will come down here and decide what to invest into. So in the case of private equity, they are buying privately held businesses. That's why the term private equity, they're buying private equity in businesses. Ta-ding, hopefully something went off there. Hedge funds use the same structure. They go and trade public securities, so they're trading stocks, bonds, futures, that kind of stuff. Venture capital right here, same structure. They go do seed and early-stage investing into startups, usually tech startups out of Silicon Valley. Real estate funds up here, same structure, they go buy and sell real estate, and when those real estate or those businesses or those trades or futures or small companies make money, the money flows back to the limited partnership and then gets split between the limited partners and the general partners, and typically you'll do some kind of fee split, a 2 and 20 model is very standard, we'll talk about what those mean in just a second. But this is kind of what you're seeing from a fund. Fund managers are trying to get you great returns, and in return, they're also going to make a lot of money as well. And in most scenarios, it's actually a very big win-win. Now, these general partners that set up a fund, these fund managers, can set rules for how their fund is going to be operated when they set this thing up. Some funds will say to be an investor, you have to have a $100,000 commitment or more to invest in our fund. Some funds will say it's a million-dollar commitment, and some funds, if you're Ray Dalio, who runs one of the largest private equity funds on the planet, minimum investment is $100 million, and you have to have a $5 billion family net worth or institution net worth to even talk to them. That's how exclusive Some of these funds are. Now you might say, why? Well, why, Bridger? Why are they sometimes kicking out investors or limiting investor capital? It's because the fund manager has to efficiently deploy that capital. You are giving them a new chunk, a $100 million chunk, that they need to go identify private businesses and go buy and sell those businesses to. It's a lot of work to deploy that much capital. And so in some of these bigger funds, they are actually kicking out sometimes investors and capital because they feel like they can only manage so much. There's only so many private businesses they can buy and sell, and so they have to do this. Hedge funds sometimes run into the same problem as well. If they're too large and they take too big of a position in a company, they actually become market makers and can actually change stock prices a lot by their trades. And actually, it's a lot harder to trade $100 million than it is to trade $100. Like, no duh, right? So that's the first thing you'll see when you're investing into a private equity fund. They'll usually have an investment minimum. Now the second thing to look for is the fee structure for these funds. Let me walk you through that right now. So I drew out a nice little timeline here. We've got 0% IRR all the way up to 20% IRR. Now a lot of funds are gonna pitch you on they're trying to beat the market, trying to give you above-average returns. So let's say for this fund we're gonna target a 22% IRR, and what would that look like for a split? Because again, these fund managers need to get paid. Now the first thing to note is IRR. Actually, this example is denoted in IRR terms. So IRR stands for internal rate of return. Now a few notes on IRR. IRR actually can be manipulated as see fit. It's an annualized number and it's pegged against the risk-free rate, which right now it's hard to deem what is risk-free. You have Fed printing trillions of dollars. It's very interesting. Other funds might use APY or a number of other things to calculate these returns. So that's the first thing to take note of. Now secondly, a lot of funds will do what's called a pref. So on this 22% example return, if we got a 22%, a lot of funds will say, hey, the first 7% or 8% is called a pref, or preferential rate of return. That means it goes directly to the limited partners or investors or you, and that is set in place to protect you. So if this year the fund only got a 7% return, all 7% would go directly to you. They'll sometimes do other examples with a hurdle rate. They all kind of try to accomplish the same thing to make sure that the fund manager is incentivized to perform. Now, once the fund hits 8%, a lot of funds will do some kind of thing called a catch-up. In my fund, the 9th and 10th percentile, 100%, goes to the general partner, the actual fund managers. And then if the fund makes over a 10% IRR, we then split 80/20. So, 80% goes to the limited partners, 20% comes to me as the fund manager. So, from— and so in this example, from the 10th percentile to the 22nd percentile, we will split 80/20. Is that making sense so far? You guys following me? So, in this example, the fund made 22%, but the investor, you, took home only 17.6%, and the fund manager took home 4.4%. So this is something you can ask when being pitched a fund. What is actually my take-home? If we had a 22% IRR, what do I actually take home at the end of the day? Now, last thing I'd like to know is a lot of funds will also take a management fee. Typically it's around 2%, and they will take that off the top. So in this scenario, they're going to take 2% first, and then they're going to go ahead and do the rest of the pref and catch-up. So that means your return will even be a little bit smaller. Than there. That's actually why in my funds I love to just pitch investors, this is what you personally will take home and should expect. It's much easier to calculate, but sometimes funds will say, hey, the IRR is going to be this, the, you know, APY and the yield and whatever it is. I like to just say, hey, what is my take-home? Boil it all down, run the numbers, what do I actually take home at the end of the day? Now, I mentioned earlier 2 and 20 model. This is what they call a 2 and 20. You have a 2% management fee and 20% That's a very standard model. Some funds might do a 3 and 30, okay? 3% management fee, 30% carry. These numbers can be tweaked. This isn't the same for every fund, but this is kind of a standard I see in the industry right now. Is that making sense? You guys following along so far? Additionally, I'm told if you guys like this video, click on the like button. It helps the YouTube algorithm. I guess my YouTube guy tells me that. So if you guys felt like you learned something so far, hit that like button. All right, next thing I want to talk about is the term of the fund. How long do most funds last? What is standard? What can I expect from these returns? There's actually There's actually 2 general types of funds. There's one called an open-ended and there's another called a closed-ended. An open-ended fund is more common in hedge funds where they will start the fund and then they will— it will go open-ended forever and investors can come in and out of the fund usually once or twice a year. They allow investors to come in and out. They recalculate all their models with new money that comes in and out and you can redeem your money usually after 18 months. You put your money in for at least 18 months. After that, you give them 6 months notice and they can kind of work your capital out. This is an open-ended model, very common in hedge funds. So a hedge fund could start with $10 million year 1 and then go to $20 million year 2, then go to $50 million, then $100 million, then $1 billion, and $10 billion over time. They can slowly grow and then actually slowly shrink as well if investors call money back. That is a much different model than the closed-ended model. The closed-ended model works like this: usually it's on a 10-year timeframe. Most these funds will set a target. We'll say, let's call this a $100 million fund target, and we're going to be working in private equity. Typically, they will do a money-raising period of the first 18 months. So that's when investors can come in and out. They might do certain closes in there, and they actually can start acquiring properties during that 18-month time period if they see fit. Now, typically, after 18 months, they will actually close the fund down. No investors can come in and or out of the fund. At this point, they obviously want to start acquiring businesses. They want to start acquiring companies. They want to follow their thesis. So for the next 2 to even 5 years, usually they can go and acquire businesses, do whatever they'd like, work on these businesses. They're going to service them, upgrade them, downgrade them, split them apart, whatever the thesis is of the private equity fund. Most funds that I've seen, usually by year 7, are trying to exit a lot of their things. Most funds that I see have a target of usually 7 years to exit all of those businesses. They're going to raise money at the beginning, they're going to buy those businesses for 2 to 5 years, they're going to upgrade them, change them, all this whatever stuff they're going to do, and by year 7, they're hoping to IPO, sell to another business, get out of the game, whatever it is. Now, they let it go for 10 years if the— let's say the economy tanks, something really bad happened, and they need to wait. If that is the case, sometimes they have the authority to wait another 3 years for the 10-year period, but they usually say, hey, at 10 years, we will— if we haven't figured out by 10 years, we'll just fire sell the businesses. We'll get out of them. We'll liquidate the assets and get you your money back. Is that kind of making sense? You're following along? But most funds target a 6, 7, maybe 8-year timeframe, sometimes less, maybe 5 years to do this, but can extend up to 10 years for you to get your returns. Now, you as an investor, will do a capital commitment to the fund at the beginning. Let's say they're doing a $100 million fund and you commit 10% or $10 million to that fund, okay? So you committed $10 million here. Now, there's a good chance they're not going to use all that capital right away, so what they usually do is they will actually let you leave that money in your bank account. You'll leave it in your bank account until they find a business to acquire, and let's say, hey, they just found a business to acquire. This business is going to be $15 million. And we're going to issue what they call a capital call. So, they're going to call capital from investors. It's 15% of the entire fund. So, you would get a capital call of 15% of your commitment. So, you committed $10 million of the $100 million. You would send a check for $1.5 million and they could go acquire their first business. And then maybe 6 months later, they're like, oh my gosh, we found another business. It's going to be great. We're going to acquire this business for $20 million. Same thing, they had 20% of your commitment, so that would be 20% of $10 million, which is your commitment. You'd send a $2 million check and they'd go in and they can call capital down. They're going to call capital for the first couple of years here. Hopefully, they're fully called and deployed by year 3, but again, you're not going to see any returns or any checks during that process. Not like you're getting like a little check every month for investing. In private equity, typically, you are waiting until the businesses sell to get a huge chunk of change back. So let's say it goes through, you did $10 million. By year 7, they go ahead, they sell the businesses, and they made a great return. They actually did very well. Let's say they doubled the business's size, right? They bought the first business for $15 million, they sold it a couple years later for $30 million, right? Pretty good return. So they're gonna calculate your check and they're gonna backdate all the years you invested. So if you invested 7 years They're going to take a 200% return, but they've got to backdate and cut it up for all the years as an annualized IRR that you would have gotten. So they doubled their money, but it took them 7 years to do it. Your IRR in that case would be in the mid-20s, which actually is a great return. They'd take their fees and come out, and you as the investor would take home a nice chunk of change at the end. Again, this is the closed-ended model. This is you're investing at the beginning, you're waiting 5, 6, 7 years, and then you're going to get all of your principal back and the sale of the business back Is that making sense? You guys are following along? Now, an open-ended model, you're typically getting distribution maybe every 6 months, every quarter, things like that, depending on the fund and when they want to distribute to partners. So it's an ongoing— you can invest on day 1 and keep it for 20 years and you'd be cash flowing maybe every quarter, every year, whatever they want to do on distributions. And sorry, our whiteboard got totally blown up here, but hopefully that made a little bit of sense on the open-ended versus closed-ended funds. Now, with that closed-ended model in mind, you've got to be in it for the long term as an investor. You cannot pull your money out at year 5 or year 4. If you don't like what's going on, they will have a very steep penalty for you to pull your money out. Sometimes even up to 50% of your capital commitment will be taken away from you if you pull out early. So I'd say if you're planning to go into a private equity or hedge fund, make sure you have the capital to put in there and you don't even have to think about it. If you're going to want to redeem capital and pull stuff out, be prepared to take a very steep penalty. And the reason they do that is a lot of these businesses aren't ready to sell. If they need to pull out your $10 million investment, they're going to have to sell shares in their businesses and change up the whole model, and actually it's going to hurt other investors. So they do it like that because they can't have investors coming in and out because it might hurt the actual investment class. Same thing's true in venture capital funds, typically real estate funds. Hedge funds are the only ones that you see where you can actually usually come in and out relatively easily. Now, with all that being said, should you invest in private equity? I don't know. It depends on your situation. Most asset managers for private wealth families will say you should allocate maybe 15 to 25% of your portfolio to— these are called alternative investments, alternative funds. I personally am a big believer in funds, and I actually have more of my portfolio dedicated to alternative asset managers because I believe they can beat the market. If you look at the Great Recession 2007-2008, hedge funds actually in general were some of the highest producing asset class, if you want to call them an asset class, in the world. Hedge funds really stayed resilient and resistant to the effects of these things. Now mutual funds got destroyed, all different types of pension plans got destroyed. Hedge funds, actively managed hedge funds and private equity and other groups, some of the highest performing groups through a recession. I'm a big believer in funds. I dedicate a lot of my net worth to funds and capital commitments in these funds because A lot of these funds, they are finding alpha. They are finding areas of the market that have inefficiencies, and they're going and solving those inefficiencies. Yes, you've got to wait a few years to get your returns back, but for me personally, it's totally worth it, and I am a true believer in investing into investment funds. Now, the last thing I'm gonna say though, make sure to invest with good managers. That's the biggest thing. That's what you're gonna have to do. Every single fund you're gonna sit down with is gonna be different. I would make sure, for me, make sure they do annual audits. Make sure— check on who their accounting firm is. Make sure they're not running a big Bernie Madoff Ponzi scheme. If they have audits, they have those things, they're going to check out. Additionally, make sure you believe in the product. Believe in what they're investing in. Believe in what they're doing. I would really drill into the fund managers, how they're putting it together. Question them on their thesis. Poke holes as much as you can. You've got to be a good manager of the money that's in your personal bank account as well. I would listen to a number of pitches before you choose a firm to go with. Now the other hard thing about a lot of funds is they are exclusive. I mentioned them earlier. They sometimes are kicking out investors. They only want a certain type of investor in their class, and also they can't publicly advertise. A lot of times you can't go out and run a billboard or run ads to find investors. These are all word-of-mouth type of investments because the SEC has rules against publicly advertising. So a lot of funds are hard to find. But once you get into the fund world, it's actually a pretty small world and you'll get connected very quickly. So, if you're looking to find funds that are looking for money, there's a few ways to go about it. Number 1, start telling people that you have money and you're looking to get into a fund. I'm sure that you're going to find a fund pretty quickly. Fund managers are always looking for new investors. So number 1, just start telling people that you're in the game, that you're looking to deploy some capital. Number 2, actually, that's why we started Investment Fund Secrets. We actually have online groups if you guys would like to join them. Online Facebook groups. I do not make any money by putting the group together. You can come in there and say, hey, I've got some capital I'd like to deploy into a fund. Who's got a fund that would like to pitch me? And I'm sure there's going to be a dozen or so fund managers that are— we try to, we try to bring fund managers and investors into the same group. We have private Facebook groups. We try to bring these people together so that they can meet one another. I don't take a commission or a fee for doing that. I just do it because we want to make this world smaller and help Capital find funds and funds find capital. So I would go in there and say, hey, I've got capital to deploy, who can pitch me? And hop on some Zoom calls, hear some pitches, and start going through this. Hopefully this episode gave you some ideas of now you're more informed about how funds work, how they're put together. Again, you've got to follow your intuition, number one, on the investment class and what's going on. Look at their tracker, look at the team, looking at the investment process and thesis of what they're doing. Now once they do all that and they check all your boxes, again, sit back and make sure this is the right thing for you. Make sure this is the right time— type of allocation. You can go with a big established fund, you could go with a brand new startup fund, right? There's a lot of different places in between. But overall, in general, I'm a huge believer in alternative investments and investment funds, and I actually put a lot of money in there. So you got to make your own decision. I'm not going to tell you what to do, but hopefully this gave you a little background on what to do in there. Anyways, drop some questions in the comments that we probably want to do a part 2 of this video that dives a little bit deeper. But let me know what you guys think. Thank you guys so much. Comment, like, subscribe the video. We try to give money out actually to new subscribers every single month, so you might win on the next video. So subscribe and like and comment, and we'll see you guys next time.