So you’ve been approached to invest in a private offering. Investing in a private company can be extremely rewarding, but it’s not without risk or challenges.
There are no guarantees that a startup will succeed, and if it fails, investors may walk away with nothing in the worst case.
Before diving into private investments, there are several vital questions investors must ask – not only of the startup but also of themselves:
What are my investment objectives?
What is your investment purpose? Is it capital preservation? Cash flow? Appreciation? Recession and inflation protection? What is your risk tolerance? What is your investment timeframe?
Knowing the answers to these questions are essential before making any investment decision and vital to aligning your investment objectives with the startup’s goals. If you seek a cash flowing business but have a low-risk tolerance with a short investment window, a technology startup is probably not a good match.
What is the experience and track record of management?
Because private investments are passive, and investors will have no hand in management, it is imperative to scrutinize the managers, their experience, and track record.
Do they have the requisite experience and knowledge in the industry, geographic market, and asset class of the central business of the company? In other words, is the particular business in the manager’s “wheelhouse”?
Be suspicious of managers undertaking a business in which they don’t have any experience.
What’s the Expected Rate of Return?
Investors are in the game to make money. Analyzing the potential return on investment (ROI) is essential to weigh the capital commitment and opportunity cost against the potential benefits.
When estimating returns, be mindful of any fees or costs associated with the investment as any management fees or business expenses may diminish any expected returns.
What is the investment time frame?
Investing in alternatives is a long-term game, but it’s essential to have some idea of the timeline as communicated by management so you can compare it to your personal expectations.
Will you have to wait ten years to realize a return, or will the company turn a profit within five? Do the managers’ track record and plan of action align with the investment horizon? In other words, are their projections realistic?
Is there a defined exit strategy?
An open-ended investment is a sure sign of a lack of vision and a plan for executing that vision on behalf of the fund’s managers.
Having a clear exit strategy is essential for investors to know when they can expect a withdrawal of their initial investment, along with any associated profits.
Are there adequate disclosures in the offering documents?
Do the offering documents provide adequate disclosures for you to gain a sense of the company’s strategy, business plan, and the likelihood of success?
Is there enough information about the company’s proposed business and adequate discussion about the industry and market trends to indicate management’s competency?
In other words, do they know what they’re talking about?
Is there enough information to be able to see through the smoke and mirrors and weigh the facts presented objectively?
What are the risks?
Nobody wants to think about their investment tanking. It’s better to know what the risks are beforehand than to lose all of your money:
- What are the market risks?
- Industry risks?
- Company risks?
- Management risks?
- Legal risks?
- Regulatory risks?
- Does management have any processes or steps for mitigating these risks?
Private investments give investors tremendous opportunities to participate in potentially lucrative ventures uncorrelated to Wall Street. However, not all opportunities are created equal, and investors should be mindful not to get suckered into just any deal.
To avoid bad deals, ask the right questions, and do your due diligence. Recognizing red flags will help you avoid bad investments and allow you to maximize the benefits of private investing truly.
Michael
