Investing In Private Companies: How To Manage The Risks

Bure Valley Group is an investment brokerage business which links successful investors with exciting, innovative UK startups seeking funding. This content is for information purposes only and should not be taken as financial or investment advice.

It’s commonly said that investing in private equity is riskier than other asset classes such as fixed income investments. Yet the potential reward can also be considerable, leading many high-net-worth investors to include them within their portfolio as a piece of their equity position. This money is committed to start-ups and similar companies which have considerable potential for growth in the short-medium term.

Managing the risks associated with these types of businesses is important to minimise possible volatility in a portfolio, and maximise the chance of generating strong returns. In this post, our investment team here at Bure Valley Group offers some thoughts on how to achieve this within the equity portion of a portfolio. We hope you find this content useful. To find out more about our own EIS and other investment opportunities, visit our portfolio page here. To enquire about our latest projects and funding, you can reach us via:

+44 160 334 0827

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Get to know the company

If you’re the type of investor who is interested in individual companies rather than simply placing your capital into the hands of a fund manager, then it’s crucial to familiarise yourself with the business you are considering. This might take the form of physically visiting their offices and/or product manufacturing facilities.

In a world of COVid-19, other approaches might involve holding a series of video meetings to meet the startup management team and pose your questions. Take a close look at how the company spends its time and money. What is the leadership of the team like? Are decisions taken haphazardly or with long-term goals in mind? Do they have a robust sales and marketing system which supports their ambitions for rapid growth?

 

Watch out for yellow/red flags

Certain aspects, features or behaviours of a prospective private equity investment should lead you to immediately be concerned and consider other options instead. Perhaps the most crucial of these is an unsubstantiated valuation where there is little room for maneuver. This suggests that the startup leadership is inexperienced and closed to feedback from seasoned investors. Another warning sign is sales concentration. Is the business standing on a precarious “peg leg” by relying heavily on revenues from just a handful of clients/customers? If the startup is also reluctant to divulge details of these individuals or businesses, then that should serve as another cause for concern. As an investor, you will need transparency about the sales base of the business if you are to have confidence in its prospects.

 

Factor in the different “risk types”

At the beginning of this post we made reference to some of the risks involved with private equity investing. Yet what do these risks look like, exactly, and how can you manage them? Here are some of the main types to look out for:

 

Investment risks

  • Liquidity risk. How easily will you be able to sell your investment at short notice?
  • Returns risk. The amount of return you’ll make on a startup investment is not guaranteed and will vary. You will need to weigh the prospects of each business to generate a strong, stable return and diversify your portfolio appropriately to manage this.
  • Principle risk. What are the chances that you will eventually get your original investment back – with interest?

 

Business risks

  • Revenue risk. Since the business in question is still in its infancy there is no guarantee that it will produce a profit. Yet it may have a number of factors in its favour which means it is more likely to do so. You will need to identify and weigh these carefully.
  • Disclosure risk. Are you confident that the company is being fully transparent with you and will continue to do so in the future?
  • Failure risk. Many startups hold out an innovative new product or service which may not have been tested in the marketplace. What are its prospects and would there be enough flexibility in the company for to pivot in the future, if required?
  • Staffing risk. When you invest in a startup you don’t just invest in the idea – you invest in its people. Do you have a clear idea of their experience, character and commitment to the business? What would happen if a key employee or leader was lost?
  • Competition risk. Does the startup face competition from other businesses? How easily could new entrant swoop in and prevent the company from achieving its desired market share?
  • Market risk. The business may strongly believe that there is consumer demand for what it proposes to sell – but what do you think? What is the size of the market, how much of it could be reasonably captured and what are its prospects for the future?
  • Control risk. The company’s company’s founders, directors, and executive officers are likely to be the biggest shareholders and, therefore, exert considerable influence. How might their interests depart from one another in the future, or from yours as a potential investor? How could this affect the stock price if the business decided to go public?

 

Invitation

Get in touch today to start a conversation with our team, and discuss some of the great investment memorandums we have available:

+44 160 334 0827

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