By , Doug and Polly White
Published May 03, 2016
Making a minority investment in a privately-held company is risky, but we’ve done it successfully.
The first step is to make sure that the company is financially sound. However, even if this is true, the pitfalls are numerous. Before investing, follow these four tips:
If you’ve read our columns, you might be familiar with the three questions that every successful business must answer:
Before you invest in a business, make sure that these three questions have been answered well. If they haven’t, you could see the value of your position decline precipitously.
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If the owner needs money to make payroll, we would suggest caution -- ensure that the business is financially sound. On the other hand, if the owner needs money for capital improvements to expand or to fund working capital for a rapidly growing enterprise, that’s a better situation. We’ve found good investment opportunities when the owner of a successful, growing business needed money for personal reasons (for example, to buy a house).
Remember, when you buy a minority interest in a small business that the majority shareholder runs, you are making a bet on that person. Good business plans are a wonderful thing, but in our experience, they always need to change. The person running the business will have to recognize changes to the competitive environment and pivot.
Without constraints, a minority interest in a privately-held business is only worth what the majority shareholder says it is worth. Consider this: You write a $100,000 check. The majority shareholder then proceeds to manage the company very successfully, generating a lot of cash.
However, the majority owner just sucks the cash out of the business by increasing his or her own compensation and never declares a dividend. Further, he or she never sells the business, but passes control to the next generation. You will never see a nickel from your investment. You might as well have flushed your money down the toilet.
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When making minority investments in privately-owned companies, insist on constraints:
Finally, insist that your prospective on the business be considered. Admittedly, this is a “gentlemen’s agreement.” You can’t force the majority shareholder to listen to your point of view. However, do make it clear up front that you want to be heard.
Making minority investments in privately-held companies is risky business. The tips above are a good start, but this is a complex topic. If you aren’t experienced, reach out to experts before investing.
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https://www.foxnews.com/us/4-ways-to-lower-your-risk-when-investing-in-other-peoples-businesses