Investing in private companies can be a great opportunity for investors seeking to diversify their portfolios and capitalize on potential returns. However, it is important to understand the process and risks involved before jumping into any investment.
The first step in investing in private companies is researching the company and its prospects for success. Potential investors should read through all available information about the firm, such as financial statements, press releases, filings with the SEC (if applicable), and other public documents. It's also important to speak with the executives of the company you're considering investing in to get an understanding of their vision for the future and how they plan to achieve it.
Once you have gathered enough information about a private company that you’d like to invest in, it’s time to determine how much you are willing to put into the company. You can purchase shares either directly from the company or through a broker or venture capital firm. It is also important to be aware of any restrictions imposed on your investment and understand the offering documents associated with the private company.
Next, investors should consider their exit strategy when investing in private companies. How long do you plan on holding onto your investment? If you don't have an exit strategy, you may find yourself tied up in a risky venture for longer than expected. Additionally, if and when you decide to cash out, make sure you factor in taxes that will be due when selling your shares.
Four Steps to Investing in Private Companies
These steps will help you get started investing in private companies.
1. Your investment strategy
Consider why you are interested in investing in private companies, and what your goals might be. Do you seek businesses that increase in value? Or do you want to generate income from your portfolio? Are you a short-term or long-term investor?
Your investment strategy for private companies should focus on understanding the company’s financial health, management team, and industry. Before investing, research the company's current financial position, track record of success or failure with previous investments, and general market trends that may impact it.
When evaluating a potential investment in a private firm, consider its risk-return profile. How much risk are you willing to take on in exchange for the possible returns? How much debt does the company have and what kind of assets does it own? How is the management team performing? How competitive is the market they operate in, and how do their products or services compare to other similar firms?
It’s also important to look at the company’s growth potential.
- How quickly is the company growing?
- How large is their customer base?
- How much money are they making?
- Has the firm been able to raise capital in the past and how much did it raise?
Finally, you should consider your own risk tolerance when investing in private companies. If you are an inexperienced investor, you may want to start small and work your way up as you become more comfortable with the process. A financial advisor can help guide you in making decisions that are best suited to your individual goals and risk profile. With careful research and a sound investment strategy, investing in private companies can be an excellent opportunity for growing your wealth over time.
Decide how you want to invest
The best way to invest in a private business is to get to know its founders and owners. In return, you can offer to invest in the business.
Decide how you want to invest in a private company, and why. There are many different ways to invest in private companies, some of which includeL
- buying stocks or equity,
- investing in debt instruments such as loans,
- purchasing convertible notes.
Each option carries unique risks and rewards that can be tailored to meet your individual needs and objectives. Once you have identified the type of investment you would like to make, research the company you are interested in investing in. Make sure to read reviews and financial statements to understand the current performance of the company and potential future growth.
Next, draft an investment proposal based on your research. This should include a detailed explanation of why you believe this is a good investment opportunity, how much money you are willing to invest, the timeframe in which you expect a return on your investment, and what type of risk you are comfortable taking. You may also want to include additional financial details or documents that can demonstrate the potential of this company.
Once you have developed a proposal, contact the company’s management with your offer. If they accept, you will need to sign a legally-binding agreement that outlines how the investment works and what each party’s responsibilities are. After everything is finalized, you can begin investing in the private company and reap the rewards of your decision!
Investing in private companies can be a rewarding experience but it is important to ensure that you understand the risks involved. Be sure to do extensive research and speak with a trusted financial advisor before making any decisions. With the right preparation, you can make a smart investment that could lead to great returns!
Accredited investors can purchase shares in private companies directly, typically through a private equity fund or from the company itself. Investors who don’t meet the SEC’s definition of an accredited investor can still invest in private companies through crowdfunding websites like Kickstarter and Indiegogo. These sites allow startups to raise money for their projects by offering rewards or giving investors equity in return for their investment. Investing in private companies through crowdfunding can be risky, as most of these companies are still in the early stages and may not produce a profitable return on investment.
Accredited investors are required to invest in private companies that have grown beyond the small business stage. You must meet these requirements to be eligible:
- A single person must have a minimum of $200,000 in income for each of the last two years
- You must be a married couple earning at least $300,000.
- A minimum net worth of $1 million, including the value of your primary residence.
The SEC reports that only 13% of U.S. households are eligible to be accredited investors, making a private investment in businesses possible to a very small number.
Despite changes to SEC rules, it is now easier to invest in private companies through crowdfunding platforms such as EquityZen and SeedInvest. These platforms allow you to buy small stakes in private companies.
The new rules allow non-accredited investors to invest up to $2,500, or 5% of their net worth or income. Individuals with a net worth or an annual income of more than $124,000 can invest up to 10%.
2. Get started investing
You will need to create a contract that details the terms of the transaction. Then you can exchange money for shares if you are investing in a company directly. If it is a private placement, the company may send you a private placement memo that details facts about the business and potential risks. You will also need to sign a subscription agreement.
You can open an account on a crowdfunding site, deposit money and then choose the opportunities you want to invest in.
Get started investing in private companies by doing your research and finding reputable brokers. Understand the risks associated with investing in a venture, as you may not have access to public information that is typically available on publicly traded companies. Make sure you investigate the company’s financial health, legal records, management team, and history of growth before investing. Consider your comfort level when it comes to risk and only invest an amount you can afford to lose.
Plan your exit strategy
It is important to understand your exit strategy when investing. Are you planning to keep the shares for a set amount of time or a fixed price? You should have a plan in place and know how to sell your investment when it comes time.
Here are some things you need to know before investing in private companies.
- Private investment is quite different from investing in public companies. It can be more difficult to assess private companies than public businesses because there are different rules regarding what information public businesses must share.
- Private companies also have a smaller market. Because there are fewer private investors who would like to purchase stock, it can be more difficult to sell shares. Private companies are not recommended for intermediate and beginner investors.
- Plan your exit strategy before you invest in a private company. An exit strategy is a process an investor uses to remove his or her money from an investment while still making a profit. Without an exit strategy, investors can become trapped in investments that have no clear exit plan or timeline. Before investing, take time to consider what potential options you could use to get out of this investment, such as a public offering, shipping the shares to another investor, or waiting for an acquisition.
Learn about the risks of investing in private companies
Private investments can be very risky. You should be aware that only half of the small businesses survive five years.4 This means that you may lose all your investment.
It can be more difficult to sell shares in private companies. It's easier to sell shares in public companies if you have an urgent need for money. Any money you invest in a private company should be considered a long-term investment.
Investing in private companies has the potential to bring high returns, but it is also riskier than investing in public companies. Private companies are less regulated and often have fewer resources than publicly traded companies, which can make them riskier investments. Additionally, there may be limited information available about a private company's financials or business operations, making it harder to evaluate the company's potential for growth or success.
The pros and cons of investing in private companies
Pros
- Potentially high returns
Warren Buffett and his renowned investment vehicle, Berkshire Hathaway, have risen to legendary status over the past three decades. His impeccable record has not only inspired small investors worldwide to mimic his methods but also shifted Omaha, Nebraska from an obscure midwestern address into a bustling hub of financial activity. Privately held companies in the U.S. are growing at a faster rate than publicly traded companies and are generating higher profit margins.
Cons
- Difficult to qualify
- Higher risk
- Less transparency
- Less liquidity
Pros Explained
- High potential returns: If the company succeeds, investing in a company can yield you large returns. When the company is small, shares are less expensive and you have the opportunity to buy in.
- Diversification can be as simple as choosing an unusual asset class. A portfolio that is diversified can help lower risk. Private equity is an asset class that offers diversification and can be added to your portfolio.
The Cons
- It is difficult to qualify: In order to invest in a private company directly, you must be an accredited investor. This means that you have a substantial income or high net worth.
- Higher risk: Half of all small businesses fail within five years. This means that investing in private companies is riskier than in larger established firms.
- Privately held companies have less transparency: Unlike public corporations, private companies are not subject to strict financial disclosure or business reporting requirements from regulators.
- There is less liquidity: It's harder to sell shares in private companies until they go public.
"We find robust evidence that public firms are associated with significantly lower operating profitability three and five years into the future when compared with private firms and that the differential future profitability is driven primarily by future profit margins." - Teri Lombardi Yohn, Professor Indiana University(source).
How to Start Investing In Private Companies with Crowdfunding
A crowdfunding platform such as EquityZen and SeedInvest is the best way to invest in private businesses.
Register for an Account
You will need to select a crowdfunding platform in order to get started. Each platform has its pros and cons.
- EquityZen, for example, helps investors purchase shares in private companies and assists with the sale of those shares, even if they haven't gone public. You can also invest in managed funds, which allow you to diversify your portfolio of private companies.
- SeedInvest, on the other hand, offers automated investing services that will allow you to build your portfolio over time. To get started, you only need $1,000.
The platform you choose to invest in is another factor that can influence your decision. There will be different opportunities on each platform.
Choose Which Private Company to Buy
- After opening an account, you will need to select the business you want to invest in. Although you can invest in several private companies, most people prefer to limit their private investments to a smaller portion of their portfolio because of the risk and lack of liquidity.
- Register for your First Transaction
Most crowdfunding platforms make it simple to invest when you are ready. You can choose the company you wish to invest in, as well as how much. You'll get shares back from the platform, and your bank will transfer the funds to it.
Here are some things to watch out for after you invest in private companies
Private investment is a long-term venture. People who invest in private companies hope the company will go public. You can sell your shares easily on the stock exchange if a company goes public. Going public is a sign that the company is performing well and that its stock prices will rise.
Remember that selling shares can result in capital gains or losses, which could lead to tax liability.
You can monitor the company's performance while you wait for it to become public. However, don't let that stress you out.
Do I need to invest in private companies?
It is not necessary to buy shares in private companies for everyday investors. Simpler strategies with less risk such as index funds can work well.
But that doesn't make buying shares in private companies a bad idea. It is possible to make a profit, and many people find it enjoyable, especially if they are interested in finance.
You should take your decision to invest in private companies seriously and carefully evaluate the opportunities. Limit your private investments to a very small percentage of your portfolio.
Frequently Asked Questions (FAQs).
How can beginners invest privately in companies?
A crowdfunding site is the best way for beginners to invest in private businesses. These websites verify private companies and make it easy for you to purchase shares. You simply need to choose which companies you want to invest in and then provide the funds.
How much money do I need to invest in private companies?
A crowdfunding site allows you to invest in private businesses without having to spend a lot of money. Each website will have its own minimum investment requirements, but these are usually reasonable. SeedInvest, for example, requires only $1,000 to begin its automatic investing program.
Which is the best way for private companies to invest?
A crowdfunding site is the best place to invest in private companies for everyday investors. These websites handle the difficult aspects of the process and vet potential opportunities before they are made available to investors. This streamlines the process of investing in private companies.
