Journal of Financial Planning: October 2025
Michael Kothakota, Ph.D., co-owns WolfBridge Wealth (https://wolfbridgewealth.com) and has 18 years of experience in financial planning. His research interests include behavior and artificial intelligence. He teaches financial planning at Columbia University. He earned his M.S. in predictive analytics from Northwestern University and his Ph.D. in financial planning from Kansas State University.
Nathan Edgerly, CPA, is founder and managing partner at Elarion Partners (https://elarionpartners.com), an evergreen private equity firm. He has over 25 years investing in private companies and has served in numerous leadership roles in operating businesses. Nate has an M.B.A. from Duke and a master of accounting from UNC Chapel Hill.
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Private equity (PE) has become a part of everyday conversation for financial planners since the signing of President Donald J. Trump’s executive order, “Democratizing Access to Alternative Assets for 401(k) Investors,” permitting the use of PE within 401(k) plans. The conversation began earlier with the announcement that the Securities and Exchange Commission (SEC) is considering changing the client qualification rules that describe which clients can invest in PE. It is challenging to scroll through even a handful of LinkedIn posts without seeing someone’s opinion on the topic. Many point to the fact that private companies comprise a much larger portion of the overall economy compared to public companies as a reason that all investors should have access to this large pool of potential investments. Yet, others have differing opinions.
Today, there are fewer companies publicly traded than there have been in the recent past. At the same time, more capital is being channeled into the public markets through automated retirement contributions and there are fewer options for investment. This is a fundamental increase in investment demand. Public company valuations are well above historical norms as a result. Meanwhile, many PE funds are holding portfolios of companies that have not performed as well as expected. In the current market environment, PE funds are having difficulty selling their companies at desirable prices and limiting their ability to provide liquidity for their fund investors.
When the accredited investor qualification guidelines were more restrictive, by definition, fewer clients were qualified to invest in PE. As such, it was an asset class that was often ignored by most financial planners. Yet, PE has the potential to yield positive risk-adjusted returns for clients and may also align with their financial goals. As private markets become more accessible to mainstream investors, it is more important than ever for financial planners to understand PE as an asset class and be able to evaluate whether or not it is a useful addition to a client’s financial plan.
What Is Private Equity?
Private equity generally refers to the investment in private (non-public) companies, usually via limited partnerships, with the goal of generating attractive returns. While PE and venture capital have similar investment structures, they have significantly different investment strategies and target company profiles. Traditional private equity targets established businesses, rather than early-stage or start-up businesses. These established businesses have revenue and other attributes that putatively make them less risky. Further, PE often differs from venture capital, in that PE portfolio management strategy includes fewer, but larger companies with the aim that most or all will increase in value. By contrast, venture capital includes more companies with the hope that a small fraction will succeed, and with the understanding that most will fail.
No two PE funds are identical, and each will have its own unique investment strategies. Even funds in the same fund family, managed by the same fund managers, can differ significantly in both the size of the fund and the size of the investments they’re making, which has implications for expected and realized returns. Some funds invest through the lens of a particular economic or industry thesis (e.g., the defense industry will benefit from increased U.S. Defense Department spending). Others are generalist funds with a specific investment instrument or structure (e.g., special purpose vehicle, share classes) that they believe to be a competitive advantage. Some funds target a particular private company segment market based on size or business model (e.g., small financial technology firms). Still others invest in regulated businesses whereas others avoid them. There are funds that are very involved with the operations of the portfolio businesses, with others being “hands-off.” A fund might make only minority or non-controlling investments, and others are only interested in majority ownership. Some funds use a lot of leverage, whereas others are more conservative. As one can see, there is tremendous variety within the private equity category. As such, financial planners must understand these nuanced details when evaluating a potential private equity investment. A thorough evaluation will take into account the variability and idiosyncratic nature of each fund within this asset class. Therefore, financial planners should be wary of anyone stating, “Private equity has an average annual return of XX percent.” Such a statement is misleading. It does not reflect expectations specific to any particular fund because returns vary wildly. However, it is useful for financial planners to understand the current landscape.
Common Challenges with Traditional Private Equity
While there are a variety of approaches, structures, and strategies within private equity, here we will provide an overview of potential challenges within traditional private equity with an aim toward providing guidance to financial planners as they evaluate PE funds and the extent to which they are appropriate for individual clients.
Mercenary management. Private equity funds often hire “professional management” to run portfolio companies, who are then incentivized by large option-and-profits-interest packages that reward outsized risk-taking in pursuit of large gains. This encourages a “mercenary” approach. Thus, there is a fundamental disconnect between the compensation framework and good risk management at the portfolio company level.
Short timelines. Private equity operates on a tight schedule. As soon as they make an acquisition, they are on a clock to exit (i.e., sell) the company with the largest gain possible as quickly as possible. On the surface, this seems appealing—buy low and sell high; investors want great internal rates of return (IRR). To do so, they aim to make high-return and/or lower-risk investments that can be sold quickly. As such, they may be more likely to invest in initiatives that are likely to generate quick results within the ownership window; in most cases this lasts three to six years.
Business strategy. Strategy, the deliberate and integrated set of choices aimed at achieving a long-term vision, is rarely a priority consideration in the context of PE. Most PE strategies, again which are incentivized to set strategies that yield quick wins, is inconsistent with decades of research that supports the idea that company strategy is one of the largest determinants of long-term business success. Dynastic businesses, with durable, sustainable strategies, can compound value at high rates of return for long periods of time with comparatively less risk.
Additionally, this short-time horizon is less able to take advantage of micro- and macroeconomic factors. Having to sell on a schedule without the discretion to wait for attractive entry prices and exit prices suppresses long-term investment returns and future longevity of the portfolio company. Without the ability to manage capital allocation with deference to capital cycles and interest rate cycles, private equity fund managers are left without critical tools for producing returns that most benefit investors and the portfolio company.
Sales cycle. The ultimate goal of PE is to not be left holding the company when the sales cycle slows. As George Strait famously sang, “I ain’t here for a long time, I’m here for a good time.” Private equity firms know they’re not necessarily making great fundamental business decisions. They just want the music to stay on long enough to exit to (1) a bigger PE fund, which is playing the same game as the previous owner, (2) a strategic buyer, who can wring synergies out to justify almost any acquisition, or (3) the public markets where information asymmetry puts investors at a serious disadvantage in valuing the business and are just excited to have more supply.
Undisciplined growth. Some PE funds engage in undisciplined growth through acquisition strategies. They buy a “platform” company in a particular industry at a high multiple and then go on to purchase smaller businesses in the industry at lower multiples. This strategy works on paper: more dollars are coming into the business through acquisition and the multiple on those acquired earnings expands to the level of the acquiror’s multiple or possibly even higher. While the positives of this strategy are obvious, it can be problematic when the strategies are not well-aligned and the companies do not integrate well. These funds deal with this problem by selling as fast as possible, leaving the work of integration to someone else. In this way, PE buying and selling depends on the “bigger fool” theory of investing. As long as a buyer is willing to pay a premium price for pro forma, run-rate adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), this strategy can work—but only for a time.
Hidden risks. Private equity investor pitches often quote the IRR and the multiple on invested capital (MOIC) to potential investors. Astute planners know IRR is a financial metric used to evaluate investment cash inflows as it relates to the initial investment, and MOIC is used to describe the expected return. Private equity fund managers are incentivized to take as little investor capital over as short a window as possible and return investor capital as quickly as they can boost their IRR and MOIC. However, IRR and MOIC fail to convey the financial risk (leverage risk, liquidity risk, and interest rate risk) associated with leverage. This is of particular concern when PE funds will use large amounts of leverage to generate merely acceptable return on equity. IRR and MOIC are not reflective of an accurate risk-return profile.
Management fee as a profit center. In traditional PE, there is a misalignment between the incentives of private equity managers and investors. The management company of a PE fund often charges significant fees in excess of actual costs to serve the fund.
Not All Private Equity Is Equal—Evergreen Funds
Of special interest is the recent innovation within PE of funds that don’t have a finite life. These funds, sometimes referred to as “evergreen” funds, employ a very different investment and business strategy compared to traditional PE. Evergreen funds managers tend to have a more disciplined approach to valuing businesses in the acquisition phase and feel less urgency to exit businesses. Instead, they focus on building the strongest possible businesses for the long term. When a buyer comes along with a very desirable offer, only then will they consider selling. So, effectively, they are disciplined in the purchase and opportunistic with the sale. If the market doesn’t ever offer a desirably high bid, then the fund is content to hold the business and generate attractive compounded rates of return through long-term ownership.
This longer-term outlook and related business strategies mitigate and often counteract many of the downsides associated with traditional PE outlined above. Perhaps the fact that many traditional PE fund managers start evergreen funds themselves after closing their funds is the strongest testimonial for evergreen funds.
Identifying Private Equity Funds Worth Recommending
Quality management. The single most important factor in evaluating a PE fund is evaluating the quality of the management, both the management of the fund and the management of the underlying businesses. It’s essential to connect with the actual decision makers and examine how they think about business, capital allocation, and risk management. Like most financial planners, evergreen private funds generally hold a long-term view. All else being equal, a management team with a long-term outlook for generating value will consistently outperform the mercenary management team.
Time horizon. Time horizon is another important factor. There’s a very specific reason for this. Private equity returns are highly correlated among “vintages.” For example, funds started in a particular year often have similar average returns over the life of the fund. This makes sense given private equity funds’ basic investment structures. They are designed to rapidly deploy and then harvest capital in that specific macroeconomic interest rate and valuation environment of five to seven years. With such a short time horizon, the macroeconomic environment can have an outsized effect on the returns the funds generate. The average returns of 2016 vintage funds may be very different from the average returns of 2022 vintage funds. Indeed, when benchmarking performance, it’s crucial to compare funds that deployed and returned capital in the same time frames.
Challenges. Financial planners are no strangers to rapid changes in the macroeconomic environment. When advising clients on public markets, we often advise clients to stay invested—and that advice is sound. By contrast, challenges that arise in the business may require a different approach by the PE firm. Traditionally, funds look to cut their losses and exit disappointing investments. Whereas most evergreen fund managers roll up their sleeves and get to work to salvage as much value as possible and bend the portfolio return curve upward through value-added effort. Understanding how the fund managers handle challenges is key to evaluating the fit for a particular client.
Track record. To evaluate a private equity fund based on track record, consider whether (1) the fund managers also ran the prior fund, (2) the new fund is the same size as the old fund, (3) the new fund has the same strategy as the old fund, (4) the factors that led to prior performance are clearly identifiable, and (5) the factors that made the old strategy attractive will persist for the foreseeable future. A discontinuity or difference in any of these factors reduces the assumption that future performance will mirror past result.
Providing Advice Around Private Equity
Investors should consider their investment in PE entirely outside of the optimized portfolio. Portfolio optimization was developed based on risk defined as volatility in the public equity and debt markets. With deep, efficient markets pricing assets constantly, the projected rates of return have risk only to the extent that the outcomes are uncertain, which is a function of historical price movements.
Most of the information available to perform mean-variance optimization is unavailable in the context of PE. While statistics like IRR and MOIC are provided, there is virtually no insight into the actual risk within the portfolio of companies. Factors like leverage, purchase price, capital cycle, interest rate risk, and managerial risk appetite are generally not available for analysis. More importantly, investors have very limited access to information about the fair market values of the portfolio companies due to the generally accepted accounting principles (GAAP) for PE and the relative infrequency of reporting. While not every private equity manager manipulates the numbers, many fund managers hold investments at cost until they sell them, so there’s zero volatility or measure of risk between investment and ultimate liquidation of the fund. Simply put, the PE fund investor does not have the information necessary to assess risk/reward. For that reason, there is no quantitative basis for including private equity in a mean-variance optimized portfolio.
Given this limitation, a financial planner can confidently recommend a PE investment to a client when a financial planner is convinced via enhanced due diligence that the investment is going to earn positive returns for their client on a risk-adjusted basis. This requires a different approach than most other investment decisions.
However, proper PE selection can be part of a plan to build durable wealth for some of your clients over time. It provides access to investments in private businesses, which comprise a significant portion of the U.S. economy.
Fortunately, astute financial planners already have most, if not all, the skills needed to assess the risk and reward associated with PE. They have a strong understanding of how business decisions are made. They understand psychology, leadership, incentives, capital cycle, discipline, execution, operations, and a variety of other aspects of real business decision-making that determine whether outcomes are beneficial or not.
Financial planners can gather the information they need to evaluate the fit of a PE fund for their individual clients in several ways. First, a financial planner must talk with those leading the investment process, ask the right questions, and thoroughly understand how those managers intend to create value over time. Do they understand these critical business ideas? Do they have time to see their thesis through for maximum value? Are they ethical? Are they committed to full transparency with investors? Do they have the talent and teams to succeed in a competitive environment? Do they think of their investors’ capital like it was their own? Do they have strong internal controls? Do they seek different opinions to challenge their ideas? Do they stay on a constant learning path? If not, the market will leave them behind. Do they have credible, credentialed outside firms looking over their shoulders to confirm they’re really doing what they say they’re doing? Do they communicate openly and frequently? A lot of this is analytical work that’s based on soft evidence, but that isn’t new to financial planners.
Providing Advice or Not, It’s Still Important to Understand Private Equity
As quickly as one day after Trump’s executive order was signed, PE has been added to some 401(k) funds. It is reasonable to expect more and more funds to include PE. Financial planners with fiduciary obligations should be discussing this change with their clients. Whether private equity is limited to some portion of a target date fund, or more directly offered to retail clients, financial planners must understand how PE works, its risks, and how to have the conversation with clients. But a financial planner who deeply understands PE and can assess whether it will be helpful for a client can add tremendous value to the relationship and meet their fiduciary obligation.