How to invest in a private company

In general, investing in public companies is much easier than investing in private companies. Listed companies, especially large companies, can easily be bought and sold on the stock market, so they have superior liquidity and quoted market value. On the contrary, it may take several years for a private company to sell again, and the price must be negotiated between the buyer and the seller.

In addition, public companies must submit financial statements to the U.S. Securities and Exchange Commission (SEC) to easily track their highs and lows on a quarterly and annual basis.Private companies do not need to provide any information to the public, so it is difficult to determine their financial status, historical sales and profit trends.

Investing in public companies seems far superior to investing in private companies, but not going public has some advantages. The main criticism of many public companies is that they focus too much on quarterly performance and meet the short-term expectations of Wall Street analysts. This may cause them to miss long-term value creation opportunities, such as investing in products that may take several years to develop, thereby hurting short-term profits. In the long run, private companies can be better managed because they are not affected by Wall Street.

Becoming the owner of a private company means sharing the profits of the related company more directly. The earnings of listed companies may grow, but unless they are paid as dividends or used to repurchase shares, they will be retained. The income of a private company can be paid directly to the owner. Private owners can also play a greater role in the company’s decision-making process, especially investors with large ownership shares.

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How to invest in a private company

Types of private companies

From an investment perspective, a private company is defined according to its stage of development. For example, when entrepreneurs start a business for the first time, they usually get funds from friends or family on very favorable terms. This stage is called angel investment, and private companies are called angel companies. When a group of more savvy investors emerge and provide growth capital, management knowledge, and other operational assistance, venture capital investment follows the start-up phase. At this stage, a company is considered to have at least some long-term potential.

After this stage, it can be mezzanine investment, including equity and debt. If the private company cannot fulfill its obligation to pay interest, the last one will be converted to equity. Late-stage private equity investment is abbreviated as private equity; this is an approximately US$2 trillion business with many large participants.

For investors, the stage of development of a private company helps determine how risky it is as an investment. For example, about three-quarters of angel investments have failed. The more developed the private company, the more profitable and the lower the risk. Although the goal of many private companies is to eventually go public and provide liquidity to company founders or other investors, other private companies may be more willing to remain privatized in light of the aforementioned benefits. Family businesses may also prefer privacy and intergenerational ownership. These are all important things to pay attention to when deciding to invest in a private company.

How to invest in a private company

Early private investment provides the most investment opportunities, but also the most risky. Therefore, joining an angel investor organization or investment group may be a good idea to simplify the process and potentially diversify investment risks to a broad group of companies. Venture funds also exist and seek external partners to invest capital, and there are small or private business brokers that specialize in buying and selling these companies.

Private equity is also an option. Ironically, many of the largest private equity companies are publicly traded, so any investor can buy them. Many mutual funds can also provide at least some exposure to private companies.

Other matters needing attention

In general, it is important to reiterate that private companies have no liquidity and require a long investment time frame. Most investors will need the final liquidity event to cash out. This includes the company going public, acquiring private shareholders, or being acquired by competitors or other private equity firms. As with any securities, private companies need to be valued to determine whether their valuation is reasonable, overvalued, or undervalued.

It is also important to note that direct investment in private companies is usually reserved for the wealthy. The motivation is that they can handle the additional liquidity and risks that private investment brings. The SEC defines these wealthy individuals as Qualified Investors or Qualified Institutional Buyers (QIB) when it is an institution.

Bottom line

Investing in private companies is now easier than ever, but investors still need to do their homework. Although direct investment is not a viable option for most investors, there are still ways to gain exposure to private companies through more diversified investment tools. Generally speaking, compared with public companies, investors will definitely need to work harder and overcome more obstacles when investing in private companies, but the work is worthwhile because there are many advantages.


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