Early-stage investment in companies used to be reserved for wealthy industry players, but in recent years it has become more common for mainstream healthcare investors to find early-stage investment opportunities. Indeed, more clients are coming to us for advice on investing in small privately-held companies, ranging from startups to existing businesses.
The potential upsides from these investments can be very large and can become very intriguing for investors looking to outperform the public markets. However, in most cases the rewards still do not outmatch the risks undertaken in a private investment. Remember, while private investments may have become easier to find, the underlying risks of those investments has not changed.
While there are stories of massive returns on small investments, they are few and far between and usually the result of good timing and excellent execution. But if an investment opportunity is touting great returns from the get-go, then the likelihood is it’s either a scam (think Pyramid, Ponzi, etc.) or just a very bad idea. Either way, the investor will be the one losing out.
So where does that leave the mainstream investor? Should they stay away from private company investments altogether and potentially miss a “home run” opportunity, or can they also participate?
The answer to the latter question is yes, provided they have their wits about them and can objectively assess an opportunity.
Investigating private markets
So how do you find out about investment opportunities in the private markets? Below is a summary of the typical ways to find an opportunity:
- Sourced through an investment group – By far the best way to source private investments; they typically require an investor to meet certain wealth and income levels and they will typically vet all opportunities so only real deals are presented.
- Presented by a professional – Typically presented to clients by wealth managers or other professionals such as lawyers or CPAs. The quality of these opportunities varies greatly. A good professional will ensure sufficient due diligence is done prior to making a presentation and that the guidelines set by the SEC are followed. In order to assess if this is a good opportunity always seek a second opinion, make sure the presenter has done suitable due diligence and understand the financial (if any) relationship between the presenter and the opportunity (i.e. do they get commission if you invest? If so, is it clearly stated up front?)
- Presented by a friend or family member – Can result in great opportunities, as you have an early look before other investors, but also comes with an emotional tie that may sway an investor into a risky deal. Care and attention need to be taken to ensure the opportunity is objectively assessed.
- Online crowdfunding (e.g. Kickstarter) – Generally high risk as most opportunities are ‘ideas’, although the investment levels can be very low. Many product-based investments will return you a copy of the product, not an actual share of the company, so the upside is limited if they are successful. There are some property-related opportunities in this space that can be interesting, but this is still an evolving concept and the requirement for good due diligence is firmly in the hands of the investor.
So once you find an opportunity what then? Below are 10 questions to ask when assessing a private investment opportunity:
- Has the lead operator(s) been successful in the past in the same or similar industry?
- What is the industry? How big of an impact can the business have?
- Is there a well-documented investment presentation that includes discussion around the market, competitors and significant risks associated with the company?
- Does the company in question have a documented business plan and strategy to execute on its objectives?
- What stage is the company in and does the value represent this stage?
- How and when will your investment start to return profits and/or principal? What is the annual return on your investment and how does this compare with your other investments?
- What is the risk of failure? Are the investors in any way obligated to provide additional funding and/or will there be saleable assets in the event the business fails to recoup some of your investment?
- Do the presented financial projections use aggressive or conservative assumptions?
- Can you afford to lose the money you plan to invest?
- How do you exit your investment? Is there a clear plan to realize a return to all investors and is this reasonable?
Once you have identified a good opportunity, it is critical to hire a professional with experience in private company investments to make sure your interests are protected and the necessary legal paperwork is completed.
Overall, private company investments can provide significant returns to investors but they also carry significantly increased risks. So if you have enough wealth to stomach a small percentage being invested in high risk/high return investments, investing in private companies may be something to consider. Just remember to be diligent and careful in your approach and always get a second opinion from an unrelated party.