Generally, it is pretty easier to invest in a public traded entity than a privately owned company. Public companies, especially the bigger ones, can be bought and sold on the stock market quickly, and that’s why they have superior liquidity and quote market value.
Contrariwise, it can take many years before they can buy and sell along with negotiation betwixt the buyer and seller in a private firm. Before beginning the investment process, entrepreneurs must carry out an online company registration as per the companies act, 2013 that makes investment legal.
Also, public companies are obliged to submit financial statements with the SEC (securities and exchange commission), making it easy to monitor their highs and lows on a quarterly and annual basis. Private companies are not obliged to give any information to the public. Hence, it can be challenging to determine their financial well-being, historical sales and profit trends.
Investment in a public company might seem superior compared to a private one, but there are plenty of benefits in not investing in a public firm. A fundamental criticism for a public firm is that they excessively concentrate on quarterly results and meet Wall street analysts’ short-term expectations. In this way, they can miss out on the long-term value-creating opportunities like investing in a product that might take years to develop, hurting profits in the short-run. Private companies are managed efficiently when it comes to long-term investment as they are out of the shadow of Wall street’s reach.
As an owner of the private firm means sharing more directly in the underlying firm’s profits. Earning might grow at the public firms, but they are kept unless paid out as dividends or used to buy back stocks. At the same time, the private company’s earnings can be directly paid to the proprietors. Private owners play a significant role in the firm’s decision-making process, especially investors with large proprietorship stakes.
How can one invest in a private company?
Types of private companies
From the investment point of view, a private company is known by its stage in development. For example, when an entrepreneur is first initiating a business, he/she usually receives funding from a family member or friend on very favourable terms. This stage is known as angel investing, while a private company is known as an angel firm. The start-up phase is venture capital investing, when a group of more intelligent investors provides growth capital, operational assistance, and managerial know-how. In this stage, the firm’s long-term potential can be seen.
Afterward, level investing, which includes equity and debts, the last of which would convert to equity if the private company cannot meet its interest payment obligations. Later-stage private investing is known as private equity, and it is approximately two trillion-dollar business with many big players.
For investors, a private company’s developmental stage can help explain how risky the investment is. For example, around three-quarters of angel investments fail. The risk comes more when the private company becomes more developed and profitable. Though many private firms aim to eventually go public and offer liquidity for company founders or other investors, other private firms might prefer to stay private given the benefits it provides. Family businesses might also prefer privacy and handling of proprietorship across the generations. These are the crucial matters to be mindful of while choosing to invest in a private company.
How to invest in a private company
Initially, private investing offers the most investment opportunities, but it comes with associated risk. Because joining an angel investor organization or investment group might be a good idea to make the process easier and potentially spread the investment risks across the vast group of firms. Venture funds also exist and seek outside partners for investing capital, and there are small or private business brokers that are experts in buying or selling these firms.
Private equity can also be an option, and several biggest private equity firms are publicly traded so that any investors can buy them. Several mutual funds can also provide at least some exposure to private companies.
Other things to consider
It is crucial to repeat that private companies are not liquid and need very long investing time frames. Many investors would require eventual liquidity events to cash out. This consists of when the company goes public, buys out private shareholders, or is bought out by a competitor or another private equity firm. As with any other security, private companies must be valued to ascertain if they are fairly valued, undervalued or overvalued.
It is also vital to note that investing directly in private firms is generally reserved for affluent persons. The reason behind that they can handle the additional liquidity and associated risk. The SEC calls these people accredited investors or QIB (qualified institutional buyers) when it is an institution.
Now, it is easier to invest in private companies. But investors are required to do their homework. When direct investment is not a viable option, investors must gain exposure to private firms via more diversified investment vehicles. But all in all, investors need to complete his/her homework before investing in private companies.