Summary
- Investing in private companies can be rewarding – both financially and emotionally – when you see small businesses grow and thrive.
- Investing in private companies is typically limited to accredited investors, who must meet strict criteria set by the SEC.
- Ways to invest in private companies include equity crowdfunding, angel investing, private equity, venture capital, secondary markets, and co-investments.
- Get connected to an advisor via Unbiased today to discuss all your investing options.
What does it mean to invest in a private company?
Investing in a private company is far different from investing in one listed on the stock exchange. Buying a public company takes a few clicks and a brokerage account, but a private company often involves sky-high minimum investment amounts, restricted access, less liquidity, less transparency, and higher risk.
It’s an attractive investment because private companies can grow 30 to 60 percent each year, earning investors substantially more than traditional investments. There’s also the potential for outsized returns when companies go public or get acquired.
However, they’re riskier investments. They’re harder to value, have longer holding periods, are harder to sell, have less transparency, and investors must be able to withstand complete losses.
Who can invest in private companies?
Not everyone can invest in private companies. Often, becoming an investor means you need to meet certain criteria, such as those required of an accredited investor.
Investors must meet one of the following criteria:
- Net worth over $1 million, excluding your private residence.
- Income of $200,000 per year ($300,000 per household).
- Investment professionals with the series 7, series 65, or series 82 licenses.
- Directors, executives, or general partners of the company selling the securities.
- Investment advisers and registered broker-dealers.
- Entities such as corporations, partnerships, trusts. 501(3)(c) organizations, employee benefit programs, and family offices with assets in excess of $5 million.
Investing in a private company involves more risk, and regulators limit the risk to wealthier individuals who can absorb a total loss.
Ways to invest in private companies
There are several ways you can invest in private companies.
Equity crowdfunding
One of the most accessible ways to invest in private companies is via crowdfunding. You can invest as little as $100 into private companies in exchange for small amounts of equity. U.S. laws allow companies to raise up to $5 million per year through SEC-registered portals.
Angel investing
Angel investors are typically high-net-worth individuals who invest directly in early-stage startups. It generally requires more capital and expertise to become an angel investor.
Venture capital and private equity funds
Venture capital and private equity funds pool money together to be managed by a general partner who selects investments to grow in the portfolio. Venture capital typically invests in early-stage companies while private equity typically focuses on established companies.
Secondary marketplaces and pre-IPO
You may be able to invest in private companies via the secondary marketplace where securities are sold from investor to investor. Just be aware that some securities are restricted and have special rules to be resold. Pre-IPO investing is usually accomplished through secondary markets.
Co-investments
Co-investments let you participate in a specific deal alongside a private equity fund. Investors don’t have to be a part of the fund, but they often are, and increasing investment for a specific deal allows for greater exposure.
How much do you need to invest in a private company?
The range for minimum investment amounts is enormous due to the different ways you can invest in a private company.
On the one hand, you could invest via a crowdfunding platform for as little as $100, but there are many private equity funds where a minimum of $1 million is the norm. It’s also typical to see angel investments between $5,000 and $25,000.
What are the risks of investing in private companies?
Private companies typically have risks that many publicly traded companies don’t have. They may be more unproven, and businesses may face unexpected challenges.
- Higher risk of loss: Private, unproven companies, especially startups, have a higher risk of total loss. You could potentially lose some or all of your investment.
- Illiquidity: Investors may need to wait years to liquidate their investments.
- Valuation uncertainty: The value of the company can be more subjective when they’re private.
- Limited transparency: Private companies don’t have the same financial reporting requirements that public companies do, so there may be less insight into the health of the business.
- Long investment horizon: Private investments last years, and there’s still no guarantee you’ll see returns on your investment.
Pros and cons of investing in private companies
To sum up, these are the pros and cons to consider before investing in private companies.
Pros
- Potential for outsized returns: Returns on investments in private companies can be very good.
- High growth potential: Private companies may have high growth potential.
- Diversification: Many private companies don’t move in tandem with markets, offering diversification in your portfolio.
- Early access to innovative companies: You may be able to support new ideas and innovations before they hit the market.
- Potential for involvement: You may be able to contribute your expertise in a private company or be involved in the terms of the deal.
Cons
- High risk: It’s possible you could lose your entire investment on a private company.
- Low transparency: Because companies are private, they have fewer reporting requirements. You’re limited to what they show you when it comes to financial statements, quarterly reports, and so on.
- Money locked up: Investments in private companies are typically locked up for years. Unless you sell your shares privately, they’re quite illiquid.
- Higher minimum investment: For many investors in private companies, you need much more money to begin investing.
- Many investors locked out: Investors in private companies are typically required to be accredited investors, which have strict requirements you must meet.
The bottom line
Investing in private companies is a potentially rewarding, even lucrative investment prospect. However, it is risky, and it may not be suitable for every investor.
If you want to get involved, but aren’t sure where to start, consider consulting with a financial advisor.
Unbiased can easily connect you to a financial advisor to answer any complex questions you have about investing in private companies.
Get connected with an advisor today.