So how do you determine which ones to say yes to, and when to walk away? More from FA Playbook: 'Investor alpha' is the most important financial strategy for How to create a charitable trust as part of an estate plan Here are 5 lessons the pandemic taught this financial advisor. Before tying up your money in one of these ventures, take the following steps to help ensure you make a good decision.
Create a financial plan: If you have a large sum of extra cash, first create a financial plan to determine your financial goals, such as paying off your mortgage or topping off your children's college accounts. This step enables you to back into the amount left over for unplanned expenses and investing.
It also gives you time to understand any offer and perform due diligence on the company. You want to plan your investment carefully and not succumb to pressure from the person asking for a commitment by a specified date. A financial plan also allows you to budget properly for this investment. I recently explained to a client that investing in private deals can be like planning a trip to Las Vegas. You should commit a certain amount of money that you're willing to roll the dice with — and leave the ATM card at home.
Examine the deal: These suitors will take many forms — a former business colleague, family member or the chief executive officer of the company. Start by finding out the following information:. A CEO or other senior leader seeking cash should have a considerable amount invested in this venture. Also, ask to speak with other private investors and about their experience to obtain unbiased information. Public information will be minimal, so it's key to do your homework.
Since financial statements of private companies aren't available, ask for a recent profit-and-loss statement and the company balance sheet, and carefully examine their pitch book for footnotes about the financials.
Next, look for a positive track record. If the company has raised capital before, how successful was that offering? What was the return, and how long did it take to return the original capital to investors? Understand that private funds don't always calculate performance using the same metrics as publicly traded investments. For example, they may use a metric called the Internal Rate or Return, or IRR, to illustrate an expected future return. Learn as much about the business operations as you can and see if their strategy for growth sounds reasonable with the right leadership in place.
In India, most upcoming entrepreneurs opt to start a private limited company rather than any other type of company. This is because it has many advantages, such as the operations of the company can be closely held by them as well as the fact that the liability arising from the company itself is limited in nature. The drawback of a private limited company, however, is the fact that the company cannot offer its shares to the public, therefore, barring it from raising investment capital from the general public.
As mentioned earlier, a private company cannot offer up shares to the public to raise capital for itself. This is only allowed for public companies. Instead, to raise capital for the business, they can only take investments from the members of the company, family and friends. Therefore capital has to be raised via private arrangements. Therefore to invest in a private limited company, one must personally approach the members of the company. There are three forms of investment options for a third party when trying to invest in a private limited company.
There are always some key points to keep in mind when one is investing in any venture. In the case of investing in a private limited company, the following are the points to keep in mind. These make it easier for the shareholder to return the shares and redeem their initial investment. But irrespective of redeemable shares, it can take a long time to achieve an acceptable return on investment if the company fails to achieve growth.
Another problem with investing in small private companies is that the founders will often have total control over the direction of the company. A PLC needs at least two directors whereas only one is required for a private company. If there is just one person who makes all management decisions, they can be more prone to taking risks compared to a PLC with an experienced board of directors, or at least one other director who is able to challenge them.
Although there is the potential for higher rewards, investing in a private company will normally come with more risks. In general, there is less regulation and transparency in respect of private limited companies compared to PLCs. Investing in private companies may not be as simple as buying stock in publicly traded firms, and there are obvious disadvantages, such as selling shares further down the line. However, there are several means to invest in privately-held businesses and clearly, there are a handful of benefits enjoyed by investors.
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