The Pros and Cons of Investing in Private Businesses

We often see public companies drive the conversation when talking about stock investments. It is their growth that we often see on the news due to the transparency of their operations.

But, privately-held companies do make up a significant sector of the economy. They may need different strategies as they do not trade in the public stock exchange. Yet, private companies can still be quite profitable. Think Deloitte, IKEA, and Rolex, among others.

But as with public companies, investing in privately-held companies can be risky. Before you dip your toes into it, here is a quick overview of what you may encounter.

The Benefits

Investing in privately-held companies can be a rewarding venture. They may not be as available as public companies in the stock market, but they offer these unique perks.

Growth Potential

Making investments towards privately-held companies can set you up for massive growth. You can take a look at startup investors, for example. Garry Tan's initial $300,000 for 2012 startup Coinbase sure paid off. After all, the company is now worth $86 billion.  

Investing in a great business idea in its earliest stages can give you massive returns. In comparison, trading in the public stock market can give you some returns. But, since these companies are in their more mature stages, there is less growth potential.

Involvement

Most investments in private companies also come with management or advising opportunities. This is especially true for smaller companies.

You can opt to put more distance between you and your investment, but you do have the option to collaborate. The bigger your investment, the greater your chances are for executive influence. You can join the company's board of directors or even take a managerial role.

This could be the perfect setup for experienced entrepreneurs and investors.

Negotiation Opportunities

Investing in a small private company can also give you more negotiating power. This can be particularly handy when talking about investment returns or advisory opportunities.

You'll have more say since you have less competition and more significant business stakes. This is in comparison to investing in public companies in the stock market.

Of course, this still considers the actual amount you put in. The higher your investment, the better your grounds for negotiation.

The Drawbacks

Private company investments may have significant potential, but they also have some risks. It's best to weigh them according to your priorities to arrive at the best decision.

Cost

Investing some of your money in a private company won't usually cut it. Most private companies require upfront funding, so you will need a significant amount to invest.

This can be difficult for newbies or those with fewer resources. Most private company investors are pretty loaded. If you want to invest, you can participate in fundraisers and other efforts. But, this won't guarantee partial ownership or other perks that more prominent investors get.

Transparency

Before making any significant investment, it is smart to research the company first. It allows you to see how the company performs and make your decisions accordingly.

Unlike their public counterparts, it is harder to research privately-held companies. They don't have to go through rigorous transparency and accountability standards. Public businesses have to file disclosure statements to the government. Meanwhile, private companies do not.

Valuation

Determining a publicly-traded company's market value can be quite simple. You can multiply their stock price by their outstanding shares.

This is not the case with privately-held companies. Since they are not on the public stock exchange, it is difficult to determine their value. One alternative is approximating their value in comparison to similar businesses. But, you may not arrive at an exact number, so it would need a bit of digging.

Factors to Consider

No matter the company, making business investments does cost quite a bit of money. Before taking such a significant step, it's best to cover your bases and consider each factor. A wise investment gives substantial returns, while the opposite might cost a fortune.

Management

This is one of the critical factors that can dictate a company's trajectory. Before investing, it is wise to get to know its CEO and key leaders.

Find out their business and professional history. It can help you discern whether the CEO can steer the company to success. One way to do this is by looking at their LinkedIn profile, social media, or online articles about them.

Business Model

A business model is how an organization gets its money. It considers their industry, customer base, and the nature of their product or service.

It's best to assess each aspect of the business model to see if it is set to succeed. Ideally, they should reach their target market and rise above the competition. As the investor, you should also comprehend and agree with how the business runs.

Financial Performance

It's essential to examine how a business is performing financially. The business model might look great on paper. But seeing the numbers would give a more accurate picture.

Obtaining this information can be challenging to do on your own. If they are staging a fundraiser, they might offer proposals for potential investors. If not, you can consider other means. If you are determined to invest in a company, you can contact them and ask for it.

Investing in privately-held companies can be a lucrative and rewarding venture. Not to mention that it's becoming more and more convenient via self-served platforms for anyone to do. Remember to be smart about it and consider your options with extreme care.