Unlocking the Potential of Private Company Investments
Investing in a private company means acquiring equity in a company that doesn’t sell shares on public stock markets. Broadly speaking, there are two types of companies: public and private. And while you are likely more familiar with public-company investments — stocks traded on stock exchanges — there are also investment opportunities to be had with private companies.
There can be benefits that come with investing in privately held companies. Depending on your current circumstances, risk tolerance, and financial goals, you will likely approach the types of companies you consider investing in differently. And it’s important to understand that there are significant risks involved, and develop your expectations accordingly.
Understanding Private Companies
A private company is one that has not or does not sell shares of itself on public exchanges. Conversely, a public company has undergone an initial public offering (IPO), which means that it has publicly issued stock in hopes of raising more capital and making more shares available for purchase by the public.
As a general rule of thumb, until a company has an IPO, it’s considered private.
Classification of Private Companies
Again, private companies are those that are not publicly traded.
Unlike the world of public investing, private investing happens off of Wall Street and takes place anywhere new, buzzy ventures are cropping up.
Public companies, especially ones that are bigger, are more easily bought and sold on the stock market, and individuals are able to invest in them. These companies are also regulated by organizations like the Securities and Exchange Commission (SEC).
The SEC is a government body that makes sure these businesses stay accountable to their investors and shareholders, and it requires publicly traded companies to share how they are doing, based on their revenue and other financial metrics.
In contrast, a privately held company is owned by either a small number of shareholders or employees and does not trade its shares on the stock market. Instead, company shares are owned, traded, or exchanged in private.
The landscape of investing in private companies can sometimes be mystifying, in part because private stock transactions happen behind closed doors. But even though private companies may be less visible than their public counterparts, they still play an important role in the economy and can be a worthwhile investment.
Investing in a private company can also be incredibly risky, and it’s important to understand some of the pros and cons of investing in this landscape.
The Growth Journey: Startups to Unicorns
Generally speaking, the goal of a startup (a small business with aims to grow quickly and possibly go public) is to become a “unicorn.” A “unicorn” company is a private company that’s valued at more than $1 billion. Very few companies become unicorns, and for investors, a primary goal is to find and invest in companies that will become unicorns.
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Start trading funds that include commodities, private credit, real estate, venture capital, and more.
Strategic Pathways to Private Investments
There are several ways to invest in private companies, though not all of them will be available to every investor.
Early Stage Investments and Angel Investing
Early-stage investing, often called “angel investing,” involves making an investment in a very small-stage company in exchange for ownership of that company. This tends to be the riskiest stage to invest, as companies at this stage are small, young, and often unproven.
Joining Private Equity Firms
Investors can also get involved in private company investing through private equity. Private equity firms invest in private companies, like angel investors, in hopes that the equity they acquire will one day be much more valuable. Again, this is likely not an option for the average investor, as private equity is usually an area reserved for high-net-worth individuals.
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Investing in Pre-IPO Companies
Some investors attempt to invest in companies before they go public to take advantage of any post-IPO spikes in share value. There are a few ways to invest in pre-IPO companies.
Leveraging Pre-IPO Investing Platforms
There are certain platforms that allow investors to make investments in pre-IPO companies. An internet search will yield some of them. Those platforms tend to work in one of a few ways, usually by offering investors access to specialized brokers who work with private equity firms, or by directly connecting investors with companies, allowing them to make direct purchases of stock.
You’ll need to dig in and do your own research into these platforms if this is a route you plan to pursue, but also know that there are significant risks with these types of investments.
The Accredited Investor’s Guide
For some private company investments, investors will need to be “accredited.” An accredited investor is an individual or entity that meets certain criteria, and can thus invest in hedge funds, private equity, and more.
Qualifications and Opportunities
For individuals to qualify as accredited investors, the SEC says that they need to have a net worth of more than $1 million (excluding primary residence), and income of more than $200,000 individually, or $300,000 with a spouse or partner for the prior two years.
There are also professional criteria which may be met, which includes being an investment professional in good standing and holding certain licenses. There are a few other potential qualifications, but those are the most broad.
Exclusive Markets for the Accredited Investor
Becoming an accredited investor basically means that you can invest in markets shut off from other investors. This includes private companies, and private equity. Effectively, being “accredited” comes along with the assumption that the investor has enough capital to be able to make riskier investments, and that they’re likely sophisticated enough to be able to know their way around private markets.
The Pros and Cons of Private Company Investments
There are pros and cons to investing in private companies that investors should be aware of.
Advantages of Private Market Engagement
Because private companies are often smaller businesses, they may offer investors an opportunity to get more involved behind the scenes. This might mean that an investor could play a role in operational decisions and have a more integrated relationship with the business than they could if they were investing in a large, public company.
In an ideal scenario, if you invest in a private company, you’ll get in earlier than you would when a company goes public. (Note: This is the ideal scenario.) And getting in early can potentially produce impressive results — if you’ve made a sound investment decision.
Another possible benefit of investing in a private company is that there is generally less competition for equity than with a public company. This means you could end up with a bigger slice of the pie.
Investing in a private company might also mean that you are able to set up an exit provision for your investment — meaning you could set conditions under which your investment will be repaid at an agreed upon rate of return by a certain date.
Generally speaking, investing in a private company can have some strong benefits, including increased potential for financial gain and the opportunity to become more involved in the future of a business.
Risks and Considerations
One of the biggest risks involved in investing in a private company is that you may have less access to information as an investor. Not only is it more challenging to get hold of data in order to understand how the company performance compares to the rest of the industry, private companies are also not held to the same standards as publicly-traded ones.
For example, because of SEC oversight, public companies are held to rigorous transparency and accounting standards. In contrast, private companies generally are not. From an investor’s standpoint, this means that you may sometimes be in the dark about how the business is doing.
In addition to this, many private companies may lack access to the capital they need to grow. And even though there may be an opportunity to set up an exit provision as an investor in a private company, unless you make such a provision, it could be a huge challenge to get out of your investment.
💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.
Critical Steps for Investing in Private Companies
Just like investing in the public stock exchanges, there are some steps that investors may want to follow as a sort of best-practices approach to investing in private companies.
Conducting Thorough Research
Always do your homework — or, as much research as you can before investing in a private company. As noted, this may be difficult, as there’s going to be less available information about private companies versus public ones. You also won’t be able to research charts and look at stock performance to get a sense of what a company’s future holds.
Identifying and Assessing Potential Deals
Through the research you are able to do (perhaps as a part of a private equity or hedge fund), you’ll want to do your best to zero-in on some potential investment opportunities. Like investing in stocks, you’ll be looking for companies that appear healthy, are competitive, and that you think have a good chance of surviving the years ahead.
There’s no magic formula, of course, but investors should do as much due diligence as possible.
The Transaction: Making Your First Private Investment
Depending on how you choose to invest, making your first private company investment may be as simple as hitting a button — such as on a private crowdfunding website or something similar. Or, if you’re directly investing with the company, it may be more involved. Just know that it’ll probably be a bit different than buying stocks or shares on an exchange.
Post-Investment Vigilance
As with any investment — public, or private — investors will want to keep an eye on their holdings.
Monitoring Your Investment
Monitoring your investment in a private company is not going to be the same as monitoring the stocks in your portfolio. You won’t be able to go on a financial news website and look at the day’s share prices. Instead, you’ll likely need to be in touch with the company directly (or through intermediaries), reading status reports and financial statements, and doing your best to learn how business is operating.
It’ll be a bit opaque, and the process will vary from company to company. So, keep that in mind.
Exit Strategies and Liquidity Events
When an investor “exits” an investment in a private company, it means that they sell their shares or equity and effectively “cash out.” If an investor bought in at an early stage and the company gained a lot of value over the years, the investor can “exit” with a big return. But returns vary, of course.
Liquidity events present themselves as times to exit investments, and for many private investors, the time to exit is when a company ultimately goes public and IPOs. But there may be other times that are more favorable to investors, if they present themselves.
Investment Myths Debunked
As with any type of investment, there may be myths or misunderstandings related to private company investments.
Setting Realistic Expectations
A good rule of thumb for investors is to keep their expectations in check. In all likelihood, you’re not going to stumble upon the next Mark Zuckerberg or Jeff Bezos, desperately looking for cash to fund their scrappy startup. Instead, you may be more likely to find a company that has good growth potential but no guarantee of survival. For that reason, it’s important to always keep the risks in mind, as well as what you actually expect from an investment.
Common Misconceptions
Some further misconceptions about private investing include that it’s only for the ultra-rich (not necessarily true, but may often be the case), that every investment may offer high returns (along with high risks), and that profits will come quickly. An investment may take years to ultimately pay off — if it does at all.
Ready to Invest? Questions to Ask Yourself
If you feel comfortable with the idea of investing in private companies and are ready to take the next step, be sure to know your own preferences before making any moves.
Assessing Your Risk Tolerance
Are you okay with taking on a lot of risk? Because you’ll probably need a high risk tolerance to be able to stomach private company investing. So, be sure to take stock of how much risk you can realistically handle, as the importance of knowing your risk tolerance will become abundantly clear as you progress in your investing journey.
Aligning Investments with Personal Goals
Also think about how your investments in private markets relate or mesh with your overall investing goals. That’s to say that you don’t necessarily want to invest in private companies just for the sake of investing in private companies — instead, think about how these investments fit into your larger portfolio.
The Takeaway
Investing in private companies entails buying or acquiring equity in companies that are not publicly traded, meaning you can’t buy shares on the public stock exchanges. This often involves investing in small companies with high growth potential — but not always, and not necessarily. Because this is a risky type of investing, there tends to be high potential rewards, too.
Investing in private companies is not for everyone, and there may be stipulations involved that prevent some investors from doing it. If you’re interested, it may be best to speak with a financial professional before making any moves.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
How much capital is needed to start?
There isn’t a limit to how much capital needed to invest in private companies, but to be an accredited investor, there are income and net worth limits that may apply.
What are the time commitments and expectations?
There are no hard and fast time commitments or expectations of private investors, in a general sense. But that may differ on a case by case basis, especially if an investor takes a broader role with managing a company they’re investing in.
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