Investors are always on the look-out for compelling investment opportunities that can generate reasonable risk-adjusted returns. Many high-networth individuals consider investments in private equities in an attempt to generate alpha and diversify their portfolios. However, just like any other investment, it is imperative to understand the various aspects of private equity investment, ranging from investment structure to an appropriate exit strategy.
Step I: Understand the company
The first factor to consider is transparency. Since private companies are not listed, there is limited information about the company that is available to the investor. You can’t simply buy the share of a private company the way you would of a listed company. In the case of a private equity investment, one needs to go through an investment banker or a mediator. You must ensure that the conduit you are relying upon is trustworthy and will act only in your best interest. Further, it would be helpful to do some additional due diligence at your end as well. Study the company’s business model, its track record with vendors and customers, corporate governance and owner credibility. This extra layer of due diligence becomes important because there is an added risk of liquidity in such investments.
Step II: Valuation of a private firm
If you want to invest in a listed firm, the market share will help you determine the worth of that listed firm. Apart from this, the financials of listed companies are available in public domain which can be used to estimate the firms’ value through various valuation methods. When it comes to valuing a private firm, there are various challenges. The main challenge is the paucity of information and availability of relevant data.
Step III: Investment structure
A number of customized structure can be created for UHNI investors seeking to invest in private firms. One can invest direct equity for a proportionate stake in the firm or use convertible instruments like preference shares, debentures, warrants to lend money to the firm. One can also opt for co-investments. An equity co-investment is basically a minority investment in a company made by a small group of individual investors, often alongside a private equity fund manager, venture capital firm or a larger fund.
Private equity investments can certainly be high risk but them come with the potential of earning tremendous returns over a 7 to 10 year timeframe. Just like any other investments, you must do your research and invest with caution