Am I Ready for a Private Investment?

Nearly every great business started as a private investment opportunity.  So too has every business failure, which far outnumber the success stories. It is however, reasonable to strongly consider this asset class as part of a diversified portfolio. Beyond that, the opportunity to own something unique, something that not everyone owns, is tempting. Whether that is an American Express Black Card, a Tesla, or your own island, it gives us an ego boost that if we’re honest, everyone likes to have. Approximately each week I receive a request from a client, or someone looking for investors, to review a private investment opportunity, many of which are local business startups. On a positive note, that would suggest a vibrant local economy, something I believe we have in central Ohio.

The challenge with private investments is the cloudy data with which we have to make our investment decision. Publicly-traded companies are required to make quarterly filings and have audited financial statements each year. This is designed to give the public some expectation of a level playing field. Unfortunately, we are all familiar with stories where this was manipulated but for the most part, this publicly available data allows us each to work off the same information when making an investment decision.

The returns in private investing can be significant, but I believe they are harder to come by. Often, when someone makes a pitch to you, it sounds great. It better, they’ve probably been working on it for some time. You have to look past that, remove any related emotion(s), and make a calculated decision as to whether this is a good investment for you. Whether you are investing in a single company, a venture capital fund, or a private equity fund, I believe you first must check these boxes before it is an appropriate risk to take. These investments are illiquid, and have a strong probability of total loss relative to a boring index fund, such as the Vanguard 500 Index Fund, which by the way has returned approximately 10.9%  annually from 08/31/1976 through 06/30/2017 according to Vanguard.

  1. You must have ample cash reserves on hand, after you make this investment.
  2. You should have consistent positive cash flow each month. (bringing in more than is going out)
  3. You should have job security, thus ensuring numbers 1 & 2 may continue.
  4. You should be max funding your retirement plan at work (retirement plans if you are married).
  5. You should be on track to meet your expected obligations as it relates to funding any future education plans, for yourself or others.
  6. I also believe you should have capital invested in liquid, public markets. To me, this shows that you have liquid investments in both retirement plans, and in personal accounts which speaks to your history of accomplishing the first 5 items.
  7. You should be an accredited investor, which if you have checked the first 6 boxes, it would appear likely that you meet the definition.

From an allocation perspective, I personally believe this asset class should be limited to 5-7% of your total investment assets. One could argue that the larger that pool becomes, the capacity for a higher percentage allocation grows as well.

Now the hard part – sourcing the right deal, then evaluating it for investment. Rarely will you hear me implore you to seek professional opinion, but this is one of those cases. Work with a CPA, your financial advisor, or someone with vast experience investing in private business to help you make a final decision.

The checklist I provided is pretty straightforward. Making the final investment decision is not quite as easy. We’ll call this WealthAdviceMadeKindaSimple.