Investing in a public company is easy. All you have to do is buy shares on the stock market to get a slice of ownership in the business. There are thousands of public companies in the US, but there are also many private companies.
It’s much harder to invest in private companies. Many of these options are limited to high net worth investors and people who have connections. However, there are some options for everyday people who want to invest in private companies.
How To Invest in Private Companies in 4 Steps
To start investing in private companies, follow these steps.
Determine your investment strategy
Think about why you want to invest in private companies and what your goals are. Are you looking for businesses that will appreciate in value or do you want to produce income from your portfolio? Are you a long-term or short-term investor?
The answers to the questions will guide you as you look for investment opportunities.
Decide on how you will invest
One of the most basic ways to invest in a private company is to get to know the company’s founders and owners and offer to invest in the business in exchange for an ownership stake.
To invest in a private company that has grown beyond the very small business stage, you need to be an accredited investor. To qualify, you must meet one of these requirements:
- Be a single person with an income of at least $200,000 in each of the past two years
- Be a married couple with an income of at least $300,000 in each of the past two years
- Have a net worth, excluding the value of your primary home, of at least $1 million
- Hold a Series 7, 65, or 82 license
According to the SEC, only 13% of U.S. households meet the criteria for accredited investors making an investment in private businesses available to just a small group.
Although changes to other SEC rules in recent years made it easier for anyone to start investing in private businesses through crowdfunding platforms like EquityZen or SeedInvest that let you buy small stakes in private businesses.
If you’re investing directly in a business, you’ll need to put together a contract detailing the terms of the transaction, then exchange money for the shares. In case it's a private placement, you may receive a private placement memo from the company detailing facts about business and risks, and also sign a subscription agreement for your investment.
If you’re working through a crowdfunding website, all you have to do is open an account, deposit money, and choose which opportunities to invest in.
Have an exit strategy
When investing, it’s important to know what your exit strategy is. Do you plan to hold the shares until they reach a certain price or for a certain length of time? Make sure you have a plan and know how you can sell your investment when the time comes.
What You Need To Know Before You Invest in Private Companies
Investing in private companies is very different from investing in public ones. For example, there are different regulations regarding the information public businesses have to share so it can be harder to evaluate private companies than public ones.
The market for private companies is also much less liquid. It can be harder to sell shares once you’ve bought them because there are far fewer people who want to buy stock in private businesses. In general, beginner and even intermediate investors should think twice before investing in private companies.
Understand the Risks of Investing in Private Companies
Investing in private companies can be highly risky. If you’re buying shares in new companies, you should know that only 50% of new small businesses last five years. There’s a big chance that you could lose all of your investment.
Also, keep in mind that it can be much harder to sell shares in private businesses. If you need money quickly in an emergency, it’s much easier to sell stocks in public companies. You should consider any money invested in a private business as locked away for the long term.
Pros and Cons of Investing in Private Companies
High potential returns
Unusual asset class can be helpful for diversification
Difficult to qualify
- High potential returns: Investing in a company before it goes public can earn you huge returns if the business succeeds. You’ll have the chance to buy in when the business is small and shares are cheaper.
- Unusual asset class can be helpful for diversification: A diversified portfolio can help reduce risk. Private equity is a unique asset class that can add additional diversification to your portfolio.
- Difficult to qualify: To invest directly in a private business, you typically need to be an accredited investor, which means having a large income or a high net worth.
- Higher risk: 50% of small businesses fail within their first five years, which means investing in private companies can be riskier than investing in a larger, established firm.
- Less transparency: Unlike public companies, privately held companies do not face stringent business or financial disclosure requirements from regulators.
- Less liquidity: Fewer people want to buy shares in private businesses, which means it can be hard to sell your investment until the company goes public.
How To Start Investing in Private Companies
If you want to invest in private companies, the easiest way for the average investor to do so is through a crowdfunding platform like EquityZen or SeedInvest.
Open an Account
To get started, you’ll have to choose a crowdfunding platform to use. Each has pros and cons.
For example, EquityZen helps investors buy shares in private businesses and also assists with selling those shares if you want to, even if the company hasn’t gone public. It also offers managed funds that let you invest in a diversified portfolio of private businesses.
On the other hand, SeedInvest offers automatic investing services, letting you build your portfolio over time. You just need $1,000 to start.
Another factor that will influence your choice is which platform the companies you want to invest in choose. Each platform will have different opportunities available.
Decide Which Private Company To Buy
Once you’ve opened an account, you have to choose the business to invest in. You can invest in multiple private companies, but most people will want to limit their private business investments to a small portion of their portfolio due to the risks and lack of liquidity involved.
Make Your First Transaction
When you’re ready to invest, most crowdfunding platforms make it easy to do. Choose the business to invest in and how much you want to invest. The platform will take the fund from your bank and you’ll receive shares in return.
What To Watch Out for After You Invest in Private Companies
Investing in private companies is a long-term endeavor. Most people who buy shares in private businesses do so with the hope that the company will eventually go public. If a business goes through an IPO, you can easily sell your shares on the stock market. Ideally, going public means that the business is doing well and that its stock price will be higher than it was when you bought shares.
Don’t forget that selling your shares will result in a capital gain or loss, which could mean paying taxes.
While you wait for the company to go public, keep an eye on its performance, but try not to stress yourself out by tracking the company on a daily basis.
Should I Invest in Private Companies?
For everyday investors, buying shares in private companies isn’t really necessary. You can do quite well with simpler strategies that involve less risk, such as investing in index funds.
However, that doesn’t mean that buying shares in private companies is strictly a bad idea. You could earn a good profit and many people find the process fun, especially if they have an interest in finance.
If you decide to invest in private businesses, make sure to take it seriously and evaluate your opportunities carefully. Also, limit your private investments to a small portion of your portfolio.
Frequently Asked Questions (FAQs)
How can beginners invest in private companies?
The easiest way for a beginner to invest in private companies is through a crowdfunding website. These sites vet private businesses and make it easy to buy shares. All you have to do is choose the companies to invest in and provide the money.
Do I need a lot of money to invest in private companies?
If you use a crowdfunding website, you do not need a huge amount of money to invest in a private business. Each site will set its own minimum investment, but they are typically reasonable. For example, SeedInvest requires just $1,000 to start on its automatic investing plan.
What is the best way to invest in private companies?
For everyday investors, the best way to invest in private companies is likely through a crowdfunding site. These sites handle many difficult parts of the process and vet opportunities before making them available to investors. This streamlined process makes investing in private companies much easier.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.