Private Equity Risks and Costs
Private Equity Risks
A private equity fund may face many risks. the main risks are listed below:
- Market Risk: Short-term market volatility may not be such a large concern given the long term investing horizon of a private equity fund.
- Agency Risk: Fund investors rely on the management of fund owned companies.
- Government Regulations: The regulations may change, which can affect the private equity firm in many ways.
- Limited Opportunities: Funds may struggle to find attractive investment opportunities.
- Capital Needs: This represents the potential inability to meet the future financing needs of fund owned companies.
- Diversification: A fund may own several companies with high correlations. If investing across multiple private equity funds, an investor should diversify across fund strategies, stages of target fund companies, and fund vintage years.
- Illiquidity: It can be difficult for an investor to quickly convert a private equity position to cash.
- Valuation Risk: Because private equity funds will own non-publicly traded companies, a large amount of judgment is involved when periodically valuing fund companies.
- Tax Code Changes: There could be changes in tax code, which can affect the fund’s returns.
Private Equity Costs
- Fund set up costs: This largely consists of legal fees.
- Management Fees and Carried Interest
- Placement Fees: This is the fees charged associated with fundraising.
- Transaction Fees
- Audit expenses
- Administrative Costs
- Equity dilution from new rounds of financing
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