What Questions Should You Ask When Investing in a Private Company?

I recently came across an article from a Canadian financial advisory firm that discussed the difference between public and private investing.

Private Investing: The Questions You Should Ask Before You Make a Move

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Having become interested in equity crowdfunding in the last couple of years, it hadn’t occurred to me that someone might have different questions for each kind of investment. 

To me, someone who makes a living writing about stocks, exchange-traded funds, mutual funds and other types of investment securities, including private investments, my goal is to evaluate each potential opportunity to decide if it’s worthy of my hard-earned savings or that of my readers.

One of Warren Buffett’s beliefs when it comes to investing in publicly traded stocks is to evaluate them as if you’re buying the entire company

“You’re buying businesses,” Buffett told CNBC’s Becky Quick in February. “[People] make decisions every second with stocks … [T]hey think an investment in stocks is different than an investment in a business. But it isn’t.”

So, rather than evaluating a stock to determine if it’s going to provide you with a surefire return, you ought to be thinking about the long-term, evaluating the business to figure out why you would want to own it. 

The biggest differences between private companies and public companies is that the latter’s shares are traded on a stock exchange, they’re easily bought and sold, the reporting requirements are far more stringent and the public disclosure is far greater.

If you’re used to investing in stocks but are new to private investing and equity crowdfunding, you’ll want to keep in mind that the amount of information available to research a private business might not be as readily forthcoming as you would find investigating a public company through documents filed with the Securities and Exchange Commission as well as those found on a company’s investor relations site. 

That said, most equity crowdfunding portals do provide a venue for online questions you might have about an individual investment. Don’t hesitate to ask them. It’s in the company’s best interest to answer them in a forthright manner. 

Now, what are the questions you should ask when considering investing in a private company? 

Here are three to get you started.

What’s the Business Model?

One of the things I’ve learned about covering stocks for more than a decade is that you can get carried away with the numbers, forgetting that if the business plan makes sense, they usually take care of themselves. 

The first thing I would ask when evaluating a private company is how it makes money. 

If you’re looking at a coffee shop, it’s not enough for the business to tell you it makes money by opening its doors each day from 9 to 9. Anybody can do that. You want to know what they’re selling, why they’re selling it, to whom they’re selling it, how much they’re selling it for, etc. 

Before you can get serious about making a private investment, you need to feel confident that the company’s business plan is realistic and achievable. Too many businesses, private and public, tend to exaggerate the total addressable market that’s available to them. 

At the end of the day, a boring business with a sensible business model and competent staff will achieve more than a trendy business with a poor business plan and Ivy League talent. Execution is everything. 

Which leads me to my second question.

Who’s Behind the Company?

Ivy League talent doesn’t matter much if the business plan isn’t worth the paper it’s written on. 

Rather than focusing on someone’s resume, although it always helps to have an experienced management team in place, I believe you want to evaluate two things: the character of those in charge and their ability to execute effectively. 

I would much rather invest in a company whose founder is passionate, honest, hardworking, customer-focused and brimming with common sense. That last one is critical. Experience, while nice, doesn’t guarantee success. 

As I said in the beginning, most equity crowdfunding portals provide a spot for investors to ask questions about the individual crowdfunding campaigns. In addition, while reading through presentation materials provided by the companies raising funds, you ought to get a sense of the people involved and their understanding of where they see the business headed. 

The great thing about equity crowdfunding is you can invest as little as $25 in some deals, which means, even if you’re new to private investing, the learning curve won’t be too costly.

Private Investing Is About Making Money

When I write about public companies, I like to talk about a company’s pathway to profitability. Investing in private companies is no different. Ultimately, the name of the game is making money. 

For many equity crowdfunding investments, the companies raising funds have revenues of some description, but they’re still building and growing their businesses. As such, many of them are losing money. That’s okay. 

However, you do want to understand how they plan to scale the business so that it will consistently make money in the future. 

So, you might ask the company the following: How much revenue will you need to generate a profit? If the business understands its margins, it should have a general idea. It’s here that the quality of answer matters. 

If you’ve ever listened to an earnings call with a CEO of a public company who understands his or her business, the answers come relatively quickly and instinctively. 

But remember, just like investing in public companies, you have plenty of options. You don’t have to put money into XYZ investment if you’re not 100% confident about your decision. 

Over time, you’ll gain experience and with that the confidence to pull the trigger faster. 

Good luck!

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.

Investing in startups through equity and real estate crowdfunding or asset tokenization requires a high degree of risk tolerance. Despite what individual companies may promise, there’s always the chance of losing a portion, or the entirety, of your investment. These risks include:

1) Greater chance of failure
2) Risk of fraudulent activity
3) Lack of liquidity
4) Economic downturns
5) Dearth of investor education

Read more: Private Investing Risks

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