Private venture investing or private company investment, as it also known, can be a risky business. In order to get the most out of your investment, you should have a comprehensive understanding of this type of investment.
In recent times, private venture investing has become increasingly popular. There are various reasons for this, as follows:
- Of late, money market returns have been lower than ever before, so private venture investing, with its better returns, is becoming a favoured choice.
- The consolidated equity created when people inherit their parents’ savings has increased the volume of private venture investing.
- Some markets are doing very well, and offer plenty of private venture investment opportunities
- Enthusiastic entrepreneurs have generated considerable interest in private venture investment.
- Those who have done well with investment in public equity are now seeking a more diversified portfolio with private venture investments.
- The formation of venture capital funds such as retirement funds have become more common in recent times, and the volumes of money here can be substantial. So entrepreneurs are increasingly generating business ideas that are likely to attract this capital.
It is important to know as much as possible about the private company you are investing in, since there are so many risks involved. A private investor can suffer considerable losses, and you should evaluate a private company investment carefully before deciding to put money into it. There are certain points you should bear in mind before making your private venture investment decision. You should be clear about your investment goals, and see whether they are viable with regard to the investment opportunity you are considering. Consider your expected reward for investing in a private venture and estimate your ROI. The risks involved should also be carefully studied to see whether the returns you will get are worth the risk you will be taking with your money.
It is a good idea to keep a written record of your investment goals so that you can continuously review performance in relation to your investment objectives. And be careful not to get tempted by apparently attractive opportunities – investigate a venture thoroughly before you invest in it.
Another important aspect to consider when you are planning to invest in a private venture is the person who is selling the opportunity to you. Do they have a vested interest? Find out the answers to the following questions before accepting a promoter’s offer with regard to private venture investment.
- Is the promoter getting a fee for persuading you to invest?
- Why did the promoter approach you?
- Has this investment opportunity been available for a while?
- Who are the other potential investors?
- Is it possible to connect with other prospective investors and conduct investigations jointly in order to save time and effort?
Never get pressurised into making an investment. The promoter, in his eagerness to earn a commission could well attempt to force you into a decision, but it is best to beware of opportunities that do not, by virtue of their quality, sell themselves. Be wary if the promoter does not allow you to contact other investors or prospective investors.
Do ensure that you go through the business plan of the venture you are considering for investment. The plan should be one that has been well drawn up, and is comprehensive and practical. Study the following aspects of the business plan:
- The important features of the private venture you are considering for investment
- The advantages offered by the investment opportunity
- What stage the business is at – is it still an idea, a start-up venture, a growing concern, turnaround or buyout?
- Financial details about areas such as debt, income and expenditure
- Current and expected income
- Assets of the enterprise
A good business plan should have:
- A short summary of the business plan as a whole
- Information about the history and past performance of the venture
- Team member designations, job descriptions and profiles
- Marketing plan information
- Customer information
- Details about compliance with law and industry regulations
- A SWOT analysis – an evaluation of the strengths, weaknesses, opportunities and threats inherent in the business venture
- Ownership information
- Organisation structure details
- Financial details, including projections for the future
- A risk analysis
When you invest in a private company, you will find plenty of information online and from other sources, which will help you identify and recognise the elements of a good business plan that has the potential for healthy returns on your investment.
It is of vital importance to study the team who is running the business you are planning to invest in. Some information will be available in the business plan presented, but this area should be gone into in great detail. Here are some questions that serve as a useful checklist when you are evaluating the strength of the team in question.
- Who are the people who will be putting the business plan into practice?
- What are their qualifications?
- How much experience do they have?
- What are their achievements?
- What terms of employment are they working under?
- Who are the operations people?
- What are their abilities?
- What is their level of engagement with the company?
- How is remuneration structured?
- Who are the consultants to the venture?
- What is the background of these consultants?
Management is a key factor when it comes to the success or failure of a business venture. You must know as much as possible about the people involved in the enterprise – a professional’s assistance may be sought in this regard.
The organisation’s structure is another area to which you should devote attention when you are deciding on a particular private venture investment. Different kinds of private ventures, such as partnerships, limited companies, joint ventures and so on, offer different investment scenarios. The factors involved in each kind of venture should be studied carefully and applied when you are making a decision on a private venture investment. Ask the following questions to get a clear picture:
- What is the legal structure of the business venture?
- Is there an offer document with upper and lower limits?
- Is your investment in debt or equity?
- Is the debt, if any, convertible or subordinated
- If insufficient capital is raised, what happens to your investment?
- Will you have any legal obligations to invest more capital at a later stage?
- Are you aware of the different kinds of ownership and the rewards for each?
There are also certain things you should bear in mind while studying the legal structure of the venture. Investment should be done through a subscription form – it isn’t a good idea to merely give a promoter a cheque to pay for your investment. The form should be perused by a lawyer and a financial expert before you go through with the investment. Using an escrow account or a lawyer’s trust account can help prevent fraud. Be very clear about the scenario that will develop if insufficient capital is raised – will your investment be returned? Will your money be stuck in a venture that does not have enough capital to go forward? Will you have to add more money to protect your earlier investment? These are things you should know before you make your private venture investment.
The ownership of the business and the control of its operations is another area that needs to be looked into when you are making a private venture investment decision. Generally, the entrepreneur who initiates the venture is the one in charge of operations, but when problems occur, the investor can question the way things are being run. Sometimes investors take over, in order to protect their investment. Companies are usually managed by a board of directors which safeguards the interest of the investor.
The usual practice is for the entrepreneur to get a share in equity, but different organisations do things in different ways, and the investor should understand the procedures and rules regarding responsibility and management of the business enterprise. Start-up ventures generally offer the entrepreneur less equity, as compared to an established enterprise, since the chances of success are less sure with the former type of business. Entrepreneurs often have a small amount of equity to start with, which increases when the venture starts generating profits.
As an investor, you should know:
- to what extent the entrepreneur has invested financially in the venture
- whether the entrepreneur will get a share of equity in return for non-financial investment in the enterprise
- how the entrepreneur’s share of equity for non-financial investment affects your own investment
- who will be running the enterprise
- whether the structure of the organisation can be changed if necessary
- whether you will have a place on the board of directors (if you want such a place)
- whether any non-financial investment is required from you
- whether you can help to enhance the likelihood of a successfully running, profitable enterprise
- whether there are any conditions or warrants with regard to your investment
When you invest in a private venture, details about ownership are generally mentioned in a Unanimous Shareholders Agreement, a document that lays down the rules with regard to problems that arise in this regard. A professional can help you understand the implications of the Unanimous Shareholders Agreement.
Think carefully about whether you really want a place on the board of directors – there are disadvantages as well as advantages and you should weigh these carefully before you ask for a place.
You also need to think about your liquidity strategy. How quickly can you get your money back out from the venture if you need it. While entrepreneurs tend to put the profits they earn from the business back into it, an investor would generally want the capital back once the venture is up and running, and generating healthy returns. Investors prefer their investment to be liquid to some degree for various reasons, and you should find out what the scenario is with the private venture you are considering for investment.
Find out when you will get your capital back (this may mentioned in the Unanimous Shareholders Agreement) and what happens when an investor wants to dissociate himself from the venture, and is replaced by another one. You must ensure that your interests are safeguarded in this regard.
Understanding the financial picture of the enterprise you are going to invest in is of vital importance when you are deciding whether to invest or not. Both historical and projected financial information should be studied, and the facts checked. Detailed financial information will help you assess the risk involved, and to develop a value analysis to understand the potential for returns on your investment.
- Audited historical financial reports
- Present financial situation
- Current financial data – is the venture in operation, and earning profits?
- Burn rate and other details if the venture is losing money
- Details about turnaround strategy
- Tax details
- An accountant’s report
- Timeframe for profit generation
- ROI details
- Timeframe for return of capital
- An estimation of the future worth of your investment
- Profit structure and methods of payout
- Details of venture’s position in the market as compared to other investment opportunities
Reports from external auditors can provide you with a lot of helpful information. If you are not familiar with the implications of financial facts, get an expert to help you understand what financial statements and audit reports mean, and how your investment is affected.
The final step before you make a private venture investment is getting a due diligence review done, with analyses by financial and legal professionals, so that every item of information is available to you. This kind of review often reveals important details that need to be considered before you invest.
- confirm the facts laid out to you while the investment opportunity offer was made
- ensure that there have been no false representations made or misleading information given to you
- review all paperwork
- check that taxes and reviews updated to the present
In any case you should always get a second opinion from an expert to help you evaluate the private venture investment opportunity accurately.
The questions here are ones you should ask to minimise the risks involved in your investment. Understand the answers to these questions clearly before you make your investment decision; they will help you make the right choice, even without an investment professional’s help.
Questions to Ask about the Investment Opportunity
- Am I clear about my investment goals?
- What will my return on investment (ROI) be?
- When will my investment yield returns?
- Do other investors think that this is a good investment opportunity?
- How long has this investment opportunity been on the market?
- Does the financial plan presented make sense?
- Is there a practical marketing plan in place?
- When will the business start showing a profit?
- When will I get a share of the profits?
- What kind of equity am I buying?
- Are share options available?
- Am I buying into debt? If so, what kind of debt is it – convertible or subordinated?
Questions to Ask about the Risk Involved
- How much risk is involved in this investment opportunity?
- If the product or service is new, am I sure that it works?
- Is the business being run in accordance with the various regulations applicable?
- How is the money invested being used?
- Is the business up and running?
- Is the business losing money, and if so, at what rate?
- Will my investment lose value when the entrepreneur gets a share?
- How much do I need to be involved?
- Can I get a place on the board of directors?
- Am I clear about the legal aspects? Do I have professional help in this regard?
- Is any party of my investment secured by assets?
- Do I have any legal obligation to invest more capital later?
- Am I clear about the company structure and how it affects my risk factor?
- Are assets and personnel of the business insured?
- Are taxes paid up to date? Is there a proper audit and assessment system in place?
Questions to Ask about the People Involved
- Are the people managing the business in question is competent, experienced and trustworthy? Do I know enough about their background? Does a background investigation by a lawyer substantiate their reputations?
- Does the same apply to the person who is offering you the deal?
- What is the team like?
- What are the details of employment with regard to the leaders of the organisation?
- What do I know about the present shareholders, the board of directors and consultants involved in the venture?