Liquidity Premium

In private equity, the liquidity premium refers to the additional return that investors can receive for committing capital to an illiquid asset class. Private companies cannot be easily or quickly sold or traded like their public market counterparts, so investors’ capital is typically locked in for longer periods, often 5–10 years or more, thus exposing them to a range of risk factors such a market volatility, economic downturns or interest rate fluctuations.

To compensate for this reduced flexibility and greater risk, investors will demand a premium in the form of higher expected returns. This excess return is known as the liquidity premium and helps explain why private equity is positioned as a higher-risk, higher-return asset class within diversified portfolios. Academic and financial industry reports such as Preqin suggest the average liquidity premium of 2% to 4% for buyout funds and 3% to 5% for riskier earlier-stage venture capital funds.