Investing in your very first company can be exhilirating. It’s a new challenge, a new learning opportunity and a new experience that’s unlike any other. However, successful investing isn’t easy. If you’re not careful, a poor investment opportunity can eat up tons of your money in the blink of an eye.Every investor wants to see their money work for them, bringing back a return that dwarfs their original investment. But, to do that, there are a number of things that you need to know, especially as a first-time investor. To alleviate your risk of losing out on a failing business, know exactly what you’re signing up for before you hand over your money.
Here are seven important tips to keep in mind.
1. Look at the brokers running the business.
There doesn’t have to be a big name behind a company for it to be trustworthy or stable. However, a big brand backing a startup certainly adds to the company’s credibility and helps solidify their financial future.
Larger names can afford to be more choosey with whom they bring on to work with the company. Smaller brokerages have to be more adaptive to pick up clientele. But, that being said, small brokerages can also be beneficial if the brokerage has a positive history. Do your research about the company and its supporters, find out who or what is involved in the company and make the decision that suits you best.
2. Wait until a company’s lock-up period Is over.
A lock-up period is a when the people who already own stock in a company are not allowed to sell it. This lowers the risk of the financial backer, as well as the risk to the stockholders, to a degree.
Wait until this period is over and look at how many of the stockowners still have their stock. This is a good indication of where the company stands and can show if the business has a plausible future, helping you mitigate your risk in the situation.
If a majority of the original stockowners are holding onto their shares, it’s likely the business is finding success and showing growth. If the original stockowners are abandoning their shares, it’s probably a sign to hold off investing in the business.
3. Read the company’s prospectus.
A business prospectus is not a fun read. It is a great insight into how a company is run and should outline risks and benefits of the investment.
Take your time to look this document over and weigh the pros and cons of investing in a business. Make sure that the business plan is clearly laid out and highly detailed. Ask yourself if the risks are worth the rewards. This will help you gain a clearer picture of the investment and help you with tip number four.
4. Be cautious.
Always be cautious about placing your money in a young business, especially when you’re looking to invest in online businesses. Caution is key to your success.
A business that sounds good on paper could be a flop in reality due poor management, a bad market or lack of focus. That’s not even touching on “businesses” that are just scams dressed up as legitimate companies. If it sounds too good to be true, it probably is.
5. Your returns may come slowly.
Small businesses need all the money they can get, which is why you shouldn’t expect to see a return on your investment in the near future. More than likely you’ll have to wait a few years to see your profits come in, especially if you’re investing in an early-stage startup.
Investing is a “big picture” move. Patience is a virtue. Don’t be surprised if you don’t see any money for the first couple of years.
6. Have an exit strategy.
With any investment, there’s always the chance that things will go wrong or simply don’t work out as planned. It’s important that you have an exit strategy if things start taking a turn for the worse. Address this with the business owners before giving them funding.
With every investment, you’re taking on some amount of risk but with an exit strategy, and explaining it from the get-go, you can give yourself a bit of a cushion on a somewhat risky move.
7. Seek the help of a financial advisor.
If you’re feeling uncertain about a particular investment opportunity, seek the help of a financial advisor. They will be the best resource available to help you avoid any loss that may come out of your investment.
Investing for the first time can be exciting, stressful, challenging and highly rewarding all at the same time. As long as you’ve prepared yourself and know what to look for in a business, how to manage your investment and what to expect in the long run, investing in your first business can be a fruitful endeavor with the potential to change your life forever.
Overall, it is much easier to invest in a publicly traded firm than a privately-held company. Public companies, especially larger ones, can easily be bought and sold on the stock market and, therefore, have superior liquidity and a quote market value. Conversely, it can be years before a private firm can again be sold and prices must be negotiated between the seller and buyer.
In addition, public companies must file financial statements with the Securities and Exchange Commission (SEC), making it easy to track their highs and lows on a quarterly and annual basis. Private companies are not required to provide any information to the public, so it can be extremely difficult to determine their financial soundness, historical sales and profit trends.
Investing in a public company may seem far superior to investing in a private one, but there are a handful of benefits to not being public. A major criticism of many public firms is that they are overly focused on quarterly results and meeting Wall Street analysts’ short-term expectations. This can cause them to miss out on long-term value-creating opportunities, such as investing in a product that may take years to develop, hurting profits in the near term. Private firms can be better managed for the long term as they are out of Wall Street’s reach. Generally, productivity increases when a public firm is taken private. They can also create more jobs when run more efficiently and profitably.
Being an owner of a private firm means sharing more directly in the underlying firm’s profits. Earnings may grow at a public firm, but they are retained unless paid out as dividends or used to buy back stock. Private firm earnings can be paid directly to the owners. Private owners can also have a larger role in the decision-making process at the firm, especially investors with large ownership stakes.
Types of Private Companies
From an investment standpoint, a private company is defined by its stage in development. For instance, when an entrepreneur is first starting a business, he or she usually receives funding from a friend or family member on very favorable terms. This stage is referred to as angel investing, while the private company is known as an angel firm. Past the start-up phase is venture capital investing when a group of more savvy investors comes along and offers growth capital, managerial know-how, and other operational assistance. At this stage, a firm is seen to have at least some long-term potential.
Past this stage can be mezzanine investing, which consists of equity and debt, the last of which will convert to equity if the private company can’t meet its interest payment obligations. Later-stage private investing is simply referred to as private equity; it is a nearly one trillion dollar business with many large players.
For investors, the stage of development a private company is in can help define how risky it is as an investment. For instance, more than half of angel investments fail. The risk falls the more developed and profitable a private company becomes. Although the goal of many private firms is to eventually go public and provide liquidity for company founders or other investors, other private businesses may prefer to stay private given the benefits discussed above. Family businesses may also prefer privacy and the handing of ownership across generations. These are important matters to be aware of when deciding to invest in a private company.
How to Invest in Private Companies
Early-stage private investing offers the most investment opportunities but is also the riskiest. As a result, joining an angel investor organization or investment group may be a good idea to make the process easier and potentially spread the investment risks across a wide group of firms. Venture funds also exist and solicit outside partners for investing capital, and there are small or private business brokers that specialize in buying and selling these firms.
Private equity is also an option and, ironically, a number of the largest private equity firms are publicly traded, so they can be purchased by any investor. A number of mutual funds can also offer at least some exposure to private companies.
Overall, it is important to reiterate that private companies are not liquid and require very long investing time frames. Most investors will need an eventual liquidity event to cash out. This includes when the company goes public, buys out private shareholders, or is bought out by a rival or another private equity firm. As with any security, private companies need to be valued to determine if they are fairly valued, overvalued or undervalued.
It is also important to note that investing directly in private firms is usually reserved for wealthy individuals. The motivation is that they can handle the additional illiquidity and risk that goes with private investing. The SEC definition calls these wealthy individuals accredited investors or qualified institutional buyers (QIB) when it is an institution.
The Bottom Line
It is now easier than ever to invest in private companies, but an investor still has to do his or her homework. While investing directly is not a viable option for most investors, there are still ways to gain exposure to private firms through more diversified investment vehicles. Overall, an investor definitely has to work harder and overcome more obstacles when investing in a private firm as compared to a public one, but the work can be worth it as there are a number of advantages.