The Pros and Cons of Investing in Private Companies
In recent times, investors have gone into purchasing private stocks more than public stocks as they see it as more advantageous than public stocks.
Some investors see the public stock market as risky and, therefore, prefer investing in less risky stocks like private companies that have chances of growing.
Also, public stocks rise and fall but most times the private stocks either maintain their position with no growth or step up with higher growth.
Though the private companies are nice, they also have their advantages and disadvantages over the public sectors.
In this article, we will be talking about the pros and cons of investing in private companies as an investor.
What is a Private Stock?
A stock is a share of the ownership of a company. It mostly consists of a portion of all the assets of a company bought off by an investor.
Investors buy shares to increase their assets when the company keeps on growing.
A private stock is a share bought by an investor from a privately owned company. When the shares are bought in a public company, it is called a public share.
How do I purchase a private stock?
There are two ways of purchasing private stocks. An investor can invest in private companies in two ways. These ways include;
- Direct Investment and
- Indirect Investment
What is a Direct Investment?
Private Companies cannot list out their shares to the public or even sell out their shares in public.
These private companies can sell out their shares or stocks directly to investors. Most of these investors are angel investors.
An angel investor is a wealthy person, focused on investing and financing small-scale businesses.
The investor buys shares from the company for a specified amount of money. More than one share can be bought by a single investor.
Investors usually go for preference shares since it is safer than other types of shares.
A preference share also known as a preference stock, is a share bought for a fixed amount and the holders get to receive their dividends first before other shareholders do.
Holders of preference shares can withdraw their investment in the case of a change of no one or if the business is crashing.
What is an Indirect Investment?
In indirect investment, investors get shares through some other investment channels other than directly buying as in the direct investment method.
These investment channels include:
Investment Trust
An investment trust is also called a closed-ended fund. This fund is publicly listed and can buy shares both in the private and public sectors.
Using the investment trust, businesses as well as individuals can buy shares and invest in companies.
A private equity trust is a type of investment trust which is only for investing in privately owned businesses.
Crowdfunding
Crowdfunding is raising an amount of money for a certain campaign, projects, charity organizations, and even small businesses from a high number of people.
Some privately owned companies, use crowdfunding platforms to also raise finance for their business.
They also sell their shares to investors using this platform. This method is mostly used by tech start-up companies but has recently been used by other companies.
A popular crowdfunding platform; Seedrs, recently launched a secondary market providing a way for private businesses to sell out their shares to the public.
This feature on the app has helped a lot of private companies not to only gather funds for their businesses but also to advertise their company and sell out their shares to investors.
Venture Capital Trusts (VCT)
Venture Capital Trusts are listed on the stock exchange but targeted at small private companies, unlike other stocks which concentrate on public companies.
Compared to the private equity fund, VCT takes minor shares in privately owned companies and the private equity funds take the major stock.
The Pros and Cons of Investing in Private Companies
Here are the advantages and disadvantages of investing in a private business as an investor.
Pros of Investing in Private Companies
1. High Chances of Growth
The private companies have a higher chance of growth and are therefore beneficial for long-time investors to invest their funds in.
With high Chances of growth, investors have a higher chance of returns in coming years when the company has achieved its stability.
Long-time investors invest in start-up companies with innovative ideas and when the company increases in worth, they have a higher asset worth.
2. Access to Early Innovations
Private investment encourages investors to research and find Innovative start-ups and invest in them.
This helps them invest and have a more valuable share than when the company reaches the public market.
As an investor of a once small private company, you have a higher asset in the company than new investors who choose to invest after the company has blossomed.
3. Involvement in the Company's Decision Making
As an investor in a small private business, you have access to deliberate and contribute actively to the decision-making of the company.
This encourages the accumulation of Innovative ideas from various investors and uses them to fuel the company's activities.
You can also make contributions and suggestions as an investor in a small private business. You're not only contributing your shares but also your ideas and suggestions.
4. Diverse Sectors
Private companies can choose to broaden their spectrum of business and engage in other sectors of business.
The diverse business structure allows investors to know about different sectors of businesses that might not even be accessible in the public market yet.
Investing in a diverse structured company gives the investor s higher chance of increasing stock value in the market.
Also, the company can decide to try out other businesses to use as a source of support it funding for their main project. In this case, the com rarely fails as they have an alternative.
5. Flexible Deals
Unlike public companies, private companies can allow their investors to make their desks to suit the market value and risk factors.
This helps investors in analyzing and making investments to go in line with their investment goals and decisions.
Flexible deals can favour both the investors and the company by making desks according to market surveys, analysis, and risks.
6. Marketing Research
Private companies help investors to be up-to-date with the latest marketing news and trends.
This makes investors conscious of their investment as well as researching the best strategy for their investment.
Marketing research also helps investors seek other investment opportunities in the stock market with a higher rate of success.
Cons of Investing in a Private Company
In as much as private companies have a lot of advantages, there also have disadvantages and risks to investors willing to invest in these companies.
1. Unavailability in the Public Stock Market
Private companies cannot list their shares on the public stock market. This makes private stocks harder to find.
Finding private companies to invest in, especially start-ups requires a lot of research and enquiries.
Potential clients have to go through the stress of thorough research to get a private business to invest in and this might cause some to lose interest.
This is an exception when the business owner reaches out to the investor first.
2. Risk Factor
Investing in already established public companies may not be as risky as investing in start-ups.
This is due to the inability to predict the future of the business even when the business has good planning.
Some investors fear the risk of these private companies going into bankruptcy and therefore invest in publicly established companies.
Even if public companies have this risk, some investors believe it is easier to gain access from public companies during liquidation than private companies.
3. Lack of Information
Unlike public companies that have their information on their platforms and are easily accessible when an investor is doing market research.
Private companies do not have much of their information available on platforms and investors can only reach out to the company's owner or management for more information.
4. Variability of Decisions
Private companies make variable decisions according to surveys or investors' opinions.
They do not have an actual already made decision regarding their business and even if present, it can be tampered with at any point in time as the business runs.
This makes the company able to change its terms at any point during business and does not have a stable decision for business growth.
These disadvantages are to show investors what they will face when investing in private business.
The Difference Between a Private Company and a Public Company
Below are the differences between a private company and a public company in tabular form.
Conclusion
As an investor looking forward to investing in private companies, there are a lot of things you need to look out for and know as discussed in this article. Researching about the company is also very important and asking necessary questions and reaching certain agreements are beneficial when investing in a private company. Do you have any questions about investing in a private company? Kindly contact Incorpuk for help today.