Investing in private companies, while risky, can be a lucrative venture, when done correctly. There are many concepts that savvy investors need to grasp - from the types of private companies, to stages of private company investment, how to invest, advantages, risks, and more. This blog post aims to give you a comprehensive understanding of the private company investment landscape and useful tips on how to unlock the potential of private company investments in your portfolio. Let’s dive in.
Understanding Private Companies
What are private companies?
Private companies are businesses that are not publicly traded on public stock exchanges like the NASDAQ or New York Stock Exchange. Their shares are not available to the general public, and they typically have fewer shareholders compared to public companies. These companies range from small, early stage startups to large, mature enterprises, especially as companies stay private longer.
Key Differences Between Private and Public Companies
Private companies are not required to disclose financial information to the public, which can lead to less transparency for investors. Public companies, on the other hand, must comply with stringent regulatory requirements and provide regular financial reports required to be publicly listed. Private companies also tend to have more control over their operations and strategic decisions since they are not subject to the same level of shareholder demands, though they are likely still beholden to a board of directors.
Benefits of Investing in Private Companies
Investing in private companies offers several benefits, including the potential for high returns and a front seat to the technologies and innovations that are shaping industries. Generally speaking, private companies tend to be earlier in their lifecycle, meaning that there may be greater potential for accelerated growth, compared to public companies. As companies stay private longer and more growth is happening while companies are private, more investors are turning to the private markets to invest in high growth companies.
Types of Private Companies
Startups
Startups are newly established companies typically focused on innovative products or services. They often seek investment to fuel growth and development. Investing in startups can be risky, especially because startups have a higher rate of failure than later stage companies. Yet they also offer the potential for significant returns if the company succeeds. Investing at this earliest stage is typically done via crowdfunding or angel investing.
Small and Medium Enterprises (SMEs)
SMEs are established businesses with a solid customer base and steady revenue. They may seek investment to expand operations, enter new markets, or develop new products. From a financing perspective, these companies have typically raised a Series A or B from investors. Investing in tech SMEs can provide more stability compared to startups, with more moderate growth potential.
Mature Private Companies (Pre-IPO)
Mature private companies are well-established businesses with a strong market presence and consistent revenue streams. They often require investment for further expansion or restructuring and have been around for over a decade. These companies can offer more stable returns and lower risk compared to startups and SMEs. The next step for many of these companies is an IPO, merger or acquisition with an IPO providing access to both a wider range of investors and more liquidity than in the private market.
Types of Private Company Investments
Angel Investing
Angel investors provide early-stage funding to startups in exchange for equity typically at the pre-seed or seed stage. This type of investment is high-risk but can yield substantial returns if the company grows successfully. Investment sizes are typically smaller as these companies typically do not need large amounts of capital to spur their initial growth. Investors at this stage typically expect to hold their investment for upwards of ten years.
Venture Capital Investing
Venture capital (VC) firms invest in startups and early-stage companies with high growth potential. They provide not only capital but also strategic guidance and resources to help the company scale. Different venture capital firms focus on different stages of the private market, with some focused on seed-stage companies and others focused on growth-equity stage investments (post Series C). Many VC firms who make an investment in a company may continue to invest in and support that company throughout their private market life and hold these investments until the company undergoes an exit. Depending on the stage at which a venture capital firm invests, they may expect to hold their investment for anywhere from two to 10+ years.
Private Equity
Private equity firms invest in more mature private companies, often acquiring a significant ownership stake. They work to improve the company's value through operational enhancements and strategic initiatives before eventually exiting the investment. The holding period for these investments may be shorter than that of VC or angel investors because these companies are already mature.
How to Invest in Private Companies
Direct Primary Investment
Investors can directly invest in private companies by negotiating with the company's founders or management team to participate in a primary round of funding. This approach typically requires thorough due diligence and a significant amount of capital, along with a strong network within the startup and venture capital ecosystem. For investors who are new to the private market investing, this is not an easily available option and is typically better suited for institutional investors.
Joining an Angel Investor Group
Angel investor groups pool resources from multiple investors to fund startups. This allows individual investors to spread their risk and benefit from the group's collective expertise. Angel groups also provide a network that helps source deal flow for participating investors. Some of these groups require an annual minimum investment commitment or charge a fee for sourcing deal flow so it is important to consider all of the details, including risks and costs, when deciding if this could be a fit.
Investing in Venture Capital or Private Equity Firms
Venture capital and private equity firms manage investment funds that acquire stakes in private companies. These investments can span from early stage to later stage companies, and across a variety of geographies and sectors, depending on the firm’s investment strategy and area of expertise. Investments into these funds typically provide diversified exposure to a number of companies with an expected investment time horizon of ten or more years1. Most institutional funds require investments of upwards of $500,000 to invest. This can be a significant amount of an investor’s overall portfolio, leading to concentration risk. EquityZen offers its own diversified pre-IPO funds to investors, focused on providing holistic access to promising pre-IPO companies with low investment minimums to help mitigate this risk and an investment horizon of up to seven years.
Using Pre-IPO Investing Platforms
Pre-IPO Platforms like EquityZen offer a convenient way for accredited investors to invest in private companies before they go public2. These platforms provide access to exclusive investment opportunities and handle the transaction process. Most platforms offer access to investments in individual companies so investors can pick the specific companies they are most interested in. With new investment opportunities launching each week, EquityZen aims to offer a wide range of investments to meet the interests and needs of our investor base.
Interested in browsing the private company investment opportunities available on EquityZen's marketplace?
Tapping the Private Market via Pre-IPO Investing Platforms
Overview of Pre-IPO Investing
Pre-IPO investing involves buying shares in a private company before it goes public. This allows investors to potentially benefit from the increase in share value when the company launches its initial public offering (IPO).
EquityZen is a platform that facilitates pre-IPO investments by connecting investors with private company shareholders looking to sell their equity. Over the past 11 years, we’ve helped investors complete over 41,000 investments in over 450 late stage private companies3. At EquityZen, we consider pre-IPO the sweet spot between early and late stage investing.
Typically, we offer investments in companies that have raised at least a Series B, have raised over $50 million in funding from top tier venture capital firms, are likely 2-7 years away from an exit and are still growing significantly. EquityZen’s platform offers investments across sectors with a focus on technology companies and companies most in-demand amongst our investors.
How EquityZen Works
EquityZen allows accredited investors to purchase shares in private companies through a secure and streamlined process. The platform handles the transaction details and ensures compliance with regulatory requirements. After over a decade in this market, our network has grown to over 660,000 shareholders and investors who come to us to buy and sell private company shares. In this time, we’ve also become experts on the pre-IPO investment process, with the goal of providing white glove service and education to both first time and seasoned investors.
EquityZen provides access to investment opportunities in high-growth private companies that can drive both portfolio diversification and the potential for significant returns. As we aim to make this market accessible to more investors, we have striven to offer some of the lowest investment minimums, while leveraging technology and our deep well of private market data to guide investors in the market.
Steps to Start Investing in Private Companies
- Conduct Thorough Research: Before investing, conduct comprehensive research on the company, its industry, and market conditions to assess its potential for success. Platforms like EquityZen will provide resources like an analysis of a private company’s cap table to help investors make informed decisions.
- Identify and Assess Potential Deals: Evaluate multiple investment opportunities and perform due diligence to identify the most promising deals.
- Make Your First Investment: Once you have thoroughly assessed an opportunity, make your first investment. Start with a smaller amount to mitigate risk.
- Monitor Your Investments: Regularly review the performance of your investments and stay informed about the company's progress and market conditions.
- Plan Exit Strategies: Develop exit strategies to realize returns, whether through an IPO, acquisition, or secondary market sale like EquityZen Express Deals.
Common Misconceptions About Private Investing
- Only for the Ultra-Rich: While some private investments require significant capital, there are opportunities available to accredited investors with various investment sizes, especially through platforms like EquityZen.
- Guaranteed High Returns: Private investments can offer high returns, but they are not guaranteed. It's important to understand the risks involved and invest wisely with an investment that is part of a more broadly diversified portfolio.
- Quick Profits: Investing in private companies is typically a long-term commitment. Expect to hold your investment for several years to realize potential returns.
Questions to Ask Before Investing
- Assessing Your Risk Tolerance: Evaluate your risk tolerance to determine if private company investments align with your financial goals and investment strategy. Many investors who work with financial advisors discuss these investments with them before making a decision.
- Aligning Investments with Personal Goals: Ensure that your investments in private companies align with your overall financial goals and long-term plans.
Investing in private companies offers the potential for high returns and a front seat to cutting edge innovation. However, it also comes with significant risks. By understanding the various stages and types of private company investments, conducting thorough research, and using platforms like EquityZen, you can unlock the potential of private company investments to enhance your investment portfolio.
Disclaimers
- Diversification does not assure a profit or protect against market loss.
- Not all pre-IPO companies will go public or be acquired, and not all IPOs or acquisitions are or will become successful investments. There are inherent risks in pre-IPO investments, including the risk of loss of the entire investment, illiquidity, and fluctuations in value and returns. Investors must be able to afford the loss of their entire investment.
- EquityZen data, as of June 2024
Interested in browsing the private company investment opportunities available on EquityZen's marketplace?
