A Primer for Private Investing
Let’s Keep This Between Us
When I was younger, the idea of investing in a private company seemed like a daydream. It was something I hoped to be able to do one day. But I knew it was going to be a very long time before those markets were open to me.
You had to be at least a multimillionaire to get your foot in the door. Or you had to know someone who was starting a company so you could be one of the angel investors. It was all about being both super wealthy and super connected.
Fast-forward not that long a time, and something fundamental has changed about that dream of mine.
You still need those connections to find out where you can invest. But thanks to the Jumpstart Our Business Startups (JOBS) Act, you no longer have to be one of the 1% to get a piece of the private pie.
The Word of the Day Is JOBS: J-O-B-S
It’s now in its third iteration. And it’s better than ever!
The JOBS Act first extended the privilege of private investing to more of us non-billionaires back in 2013. And with every update, it’s expanded the number of people who are eligible to invest in private companies.
Initially, the JOBS Act classified “accredited investors” in several ways:
You had to be an individual with net a worth surpassing $1 million (excluding the value of your home) or with an annual income above $200,000 for the past two years ($300,000 if you’re a couple) and have the expectation to make the same amount or more in the current year.
Individuals who are general partners, executives, or directors for companies that issue unregistered securities were also included as accredited.
Private business development companies with assets over $5 million were counted among accredited investors as well.
In 2016, Congress modified the definition to include registered brokers and investment advisors. And the new language included anyone who can show he has “sufficient education or job experience showing his professional knowledge of unregistered securities.”
It may not sound like it, but that’s a lot of people. And regulation A+ of the JOBS Act added even more: every single one of us.
You may be more familiar with Reg A+ by its colloquial name: crowdfunding. It’s when a company offers equity (ownership) in the firm in exchange for a cash investment.
And thanks to Reg A+, these companies can offer shares to non-accredited investors, too. There’s a limit on how much you can invest based on your net worth and annual income. But you can invest no matter who you are and how much you make.
But just because you can invest in a company doesn’t mean you should. There are lots of stocks out there you wouldn’t touch with someone else’s money. There are a lot of private companies out there you shouldn’t, either.
So, how do you tell if it’s a company you should buy or one you should run from?
Well, there are a couple ways you can estimate the value of the company. And that’s the best place to start to decide if it deserves your investment.
Is It Really Worth It?
When you’re buying stock, it’s pretty easy to assess value. Financial statements are public record. There are tons of comparables. But private companies aren’t required to report earnings and submit financials to the SEC. So it’s a little more complicated...
But there are still a few ways private investors can estimate the value of a company. Remember, you’re a potential investor.
If you ask to see financials, they should deliver. You might have to sign an agreement that you won’t share them. But if they won’t let you look under the hood, you probably don’t want to buy the car.
First, you can do a comparable company analysis. Sounds a little complicated on the surface, but it’s just finding similar companies in the same industry that are already publicly traded.
You look for public companies of similar size, age, and growth rate. Once you find a handful, you’ve got a peer group. You can take averages of their valuations and multiples and compare your company to them.
You can also look for similar companies that have been bought by larger operations. That will also give you a good idea of how the market values companies like yours.
The only issue with this method is that the company has to be selling something to be comparable to those public firms. So what do you do if you’re considering a company that has a product but isn’t bringing in any revenue yet?
Pre-Sales Valuation and the Rule of 10
This is where it gets a lot tougher to decide if it’s worth your money. You really don’t have anything to go on but the projections the founders have for how well they can do.
But there are still ways to at least get to a close estimate of what the company might be worth. Just remember the "rule of 10" with this kind of investment.
If you’re getting in pre-revenue, you’re likely a very early investor. And early investors expect at least a 10x return on their investment.
That means every $10,000 you invest better come out as $100,000 in the end.
Some angel investors and venture capitalists are looking for even more — 20x or 30x returns. But if you get a 1,000% profit on your private investment, you’re still doing pretty well.
So, how do you spot those 10-baggers before they even have customers?
Well, unfortunately, there’s no exact science to it. In the end, it’s a well-researched educated guess.
But there are steps to take to get you in the right direction...
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Look at the founders. Are they your fishing buddies who think they’ve got a good idea? Are they your nephews who went to MIT? Or are they Jeff Bezos and Elon Musk?
Who’s founding the company and the experience and knowledge they have make a big difference in what the company is worth and how much you’ll want to commit.
Look at the company’s path to revenue. Is it short and well planned? Do the founders expect sales to start this year, next year? What customer relationships already exist?
If a company has a clear and direct path to generating revenue, it’s worth a lot more than one with a product but no defined market.
You’ll want to look at potential growth as well. What’s the market size?
If there are 500,000 potential customers, the company is going to be worth a little. But if there are 500 million potential customers, the company has a much better chance of success and is going to be more valuable.
You’ll also want to assess competition in the market. If there is none, your startup could become the first-mover and be a very valuable investment.
But if there’s already stiff competition and high barriers to entry, it’s going to take a lot of work and cash to break into that market. You might still want to invest, but you’re not going to value the company so highly.
Look into who else is investing in the company as well. If you’re thinking about helping fund a tech startup and Sequoia Capital is also an investor, you’re probably safer than if the founder’s aunt and uncle are the main funders.
And, again, try to find comparables. There are bound to be other similar companies out there. If they’re all getting a similar valuation, you can use that as a guide to valuing your potential investment, too.
Building Something Big
It’s a very exciting time as more and more people become eligible to invest in private companies. But remember when I said the connections still matter?
Well, they’re really the most important part. It’s those connections that get you in on the early funding rounds. It’s those connections that help make sure you’re getting that 10x, 20x, or 30x return.
And it’s also those connections that are the hardest thing to come by. Without them, you might get one or two great private deals in your career.
But it takes a lifetime of networking to build up the kind of contact list that can deliver you endless private opportunities.
You’ll also remember that private investing has been a dream of mine for years. And while I’ve been saving my money and investing in the stock market, I’ve also been growing my network of private industry contacts.
And I’m running into a problem I only ever dreamed I’d have: I’m getting too many offers. I just don’t have enough friends and family to share them all with.
So I’m working with the owners of our parent company, Angel Publishing, to create a private investment advisory service. This will be one of the first of its kind.
But since we’ll be focusing on private investments, there’s a ton of red tape to wade through. So it’s going to take some time to get everything set up. But once everything is OK’d by our legal team, I’ll be opening the doors for a limited number of people.
You’ll be able to take advantage of a lifetime of connections I’ve made throughout my career on Wall Street, in the Department of Defense, and just by being in the right place at the right time.
Like I said, all the legal t’s and i’s need to be crossed and dotted before I can start sharing these opportunities. But I will be keeping my current investing community updated on the progress.
And they’ll get the first opportunity to join my new private advisory service.
If you’d like to join them and secure your spot in line, just click here and sign up for The Wealth Advisory today.
The recommendations you’ll get between now and when the private deals start flowing will easily pay for your subscription. And they’ll give you even more cash to put to work in the private opportunities to come.
To your wealth,
To your wealth,
After graduating Cum Laude in finance and economics, Jason analyzed complex projects and budgets for the U.S. Army. Then, at Morgan Stanley, he led the assistants' team for the North American repo sales desk, responsible for hundreds of multibillion-dollar trades every day. Jason is the assistant editor for The Wealth Advisory income stock newsletter. He also contributes regularly to Wealth Daily. To learn more about Jason, click here.
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