Looking to invest in a startup or small business to enhance your portfolio?
Before you reach for your check book, make sure you have completed your due diligence first. Investing in private companies can have a great payoff, if you have the right information, a well-documented investing plan and the right market research. Without the key components to conducting an investigative research into the company, you could be just throwing money down the drain. There are multiple steps that should be considered when investing in private companies. Consider the eight steps below as the minimum due diligence required.
Set an Investment Objective
Before you invest in anything, from stocks or bonds to private companies you will need to set your own objectives. These investment objectives are essential to successful investing. They will be keep you grounded and focused on your end goal; which should be wealth creation, tax mitigation, or wealth preservation. Do not invest in a friend or family scheme, if it does not fit into these objectives.
Only Gowith a Plan
If someone tries to sell you an investment based off an idea, napkin drawing or a concept, it’s time to turn the other way. Only ever invest in a company that has a well-written Business Plan that you can understand how they will execute and meet their final objectives. If you do not understand pro-forma documents, balance sheets or cash-flow statements, get help before making any decisions.
There are generous tax incentives for investing in a private company which reduce the risk and you should make sure that your investment benefits from these. Taxes for businesses including capital gains taxes can often eat your rate of return.
Capacity for loss
Before you invest, you should consider what your capacity for loss is. If you do not have the capacity to lose capital, a private company investment may not be right for you as an angel investor.
As an investor you should not only have access to the owners of the company, but you need to know they are committed to the venture. Commitment should come in the form of real risk and loss. How much money or time have the entrepreneurs put into making the company a success? This is a question that once answered will let you know how serious the leaders of the company are about its ongoing success. If the entrepreneurs have nothing at stake, then you should walk away, just like they can at any time in the future.
Get it your way
If you are making a significantinvestment in a startup, you should have a considerable say in how the investment is structured. Understand the different ways you can be compensated by the company and how those will affect your personal tax. Structure the deal your way. An investment should be structured in a way that is favorable to you. If you cannot get it your way, it’s not the right investment for you.
It shall be written
Any investment should be concisely documented outlining the exact terms you expect. If the terms of the investment such as share options or anything else are not written in a contract, they might as well be fancy unicorns, prancing out of your reach. Any contracts should be reviewed by an experienced and appropriately qualified lawyer prior to you signing them. This is a protection for all parties involved, especially you.
Exit with style
If there is no exit plan, make your grand exit before you have even signed the deal. This is one of the biggest hazards for many private company investors. If you aren’t sure from the beginning what your goals or prior to exiting, you may find yourself staying too long and to your detriment. You are an investor, if you want to be an owner you could probably start your own company. As an investor you should always have a written plan showing how you are going to get out.
When investing in private companies there are many pitfalls. Stepping into the ring without effective coaching can easily lead to a knockout for your precious capital. However, if you have the right advisors and coaches you can easily invest with confidence in a startup or enterprise seeking investors.