How Risky Are Private Equity Investments vs. Other Investments?

An Investopedia article examines how the risk of private equity compares with other asset classes. The piece describes private equity firms as funds that pool investor money with borrowed financing to acquire equity stakes in established companies or startups with significant growth potential. Firms often attempt to raise profitability by replacing management teams and boards, cutting costs, adding products and services, and in some cases selling part of a company through a spinoff. The article notes that high-net-worth investors have increasingly allocated a portion of their equity positions to alternative assets, including private equity, and that wealthy individuals and institutions such as pensions, mutual funds, and insurance companies are typical investors.

The article identifies several categories of risk. Investment minimums are high, which the article says can be as much as $25 million, although some firms cater to investors with minimums of $250,000. Because large sums are committed, gains on small percentage returns can be substantial, but losses can be equally significant. Liquidity risk is also central: earnings growth at small companies takes time, and private equity investors are expected to leave capital with the firm for four to seven years on average, with some investments requiring longer holding periods.

Market risk is another concern. The article states that there is no guarantee portfolio companies will grow at all, and cites U.S. Bureau of Labor Statistics data that about 1 in 5 startups fail in their first year. It also cites a 60% year-over-year increase in venture-backed startup failures in 2024. Failures can result from ineffective management, a failed product launch, or a technology rendered obsolete by competitors. The article adds that default risk is lower for established companies than for startups, while heavy use of debt in private equity deals can be costly to service.

The article notes that private equity firms manage risk through due diligence before committing capital and through ongoing diversification, hedging, risk modeling tools, continuous monitoring, and active liquidity management. It concludes that the risk profile of private equity is higher than that of other asset classes, but that for investors with sufficient funds and risk tolerance, it can be a lucrative portion of a portfolio.