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The 7 rules You should use to invest in Private Equity start-ups


The 7 Rules, You should follow, to Invest wisely in Start UP’s and Private Equity, which all Private Investors should know.

I once met an Old School Stockbroker that specialized in Enterprise Investment Scheme and Small Company stock issues. He told me that of the 25 years in broking most of his clients had lost money investing in small-capitalized companies.

I contrasted this with my experience in Private Equity where the company, which I worked for, worked closely with private investors and business angels. Most of the investors were High Net Worth Individuals and or sophisticated investors who had made several investments.

For those new to the game we provided them with important points on what to look for in a new business.

Many investors lack a structured route that they follow when they invest. Typically they will read an article in the Mainstream Media, or an investor forum. Sometimes the invest it’s because they like the idea or know the industry. One of the worst reasons for an individual to invest is just for any tax breaks. There is no point in having generous tax breaks on investments, if that investment has a high probability of failure due to poor due diligence.

So here are the 7 criteria you should consider before investing:

1. The Business idea. A good business idea for an entrepreneur or investor is like seeing a £50 note laying on the ground. Your first thought is: “Is this genuine?” Then “Has anyone else seen this?” and then “Better snap this up now before someone beats me to it”. The Business idea has to resonate with you. Maybe you have knowledge of the concept, or that it just sounds right. Often times it seems so obvious.

2. The Market; is this an environment that is growing, is the market very competitive, are the barriers of entry very high. If so it maybe where most of the capital will be tied in. Who needs to break into the typewriter business nowadays?

3. The scalability – in private equity you want to be a grizzly bear not a teddy bear The business should have the capacity in which to grow and grow big not be a small profitable cottage industry. The technology sector ticks a lot of boxes, in this regards ,because of the scale potential is vast. The likelihood of being able to grow in terms of the number of customers or the volume of sales will be the making or breaking of many a Business with a great idea.

4. Now you should turn to the financials. This is where you put your head under the bonnet and ask are the figures adding up? If the businesses figures are not correct or do not make sense then this is a question mark on their ability to manage matters financially. Also, it provides a window to their perspective relative to the Market in which they are looking to enter.

5. The Management, Who manages the business is critical. Often times it is the experience of the management team, their qualifications, contacts and more importantly their drive that determines it's success. All these factors will impact positively or negatively on the ventures success. What have they done before? Have they been directors of many companies in the past? Were the management high flyers in their previous positions? Do you remember the Long Term Capital Management story management and it's assumptions are critical to the businesses outcomes?

6. The Investment: How much do they want you to invest? What are you getting for this amount; will it be an active role or a passive role? Is the investment a Bond, if so is it asset backed or will it be shares? If they are shares what type? Are you the first in or have they already had a round of investment? What is the investment for? An obvious question, but one that is obscured when an investor sees $$$ signs or the glossy brochure.

7. The Exit; this is very important, how long are you expected to hold the investment? As Fagan said in "Oliver Twist" :

“Only one thing counts and that’s money in the Bank in large amounts”

So forget paper profits, doesn’t matter how great the business is doing if you cannot exit your investment then what the point.

You will need a clear explanation as to when you should expect to get a return on your investment and how much that is likely to be? For example if you have a bond which is paying you a coupon of up to 10% a year for 5 years then your risk is going to be up to the point of full repayment of the amount invested, as if the business fails in year 4 and 6 months ,while you may have received 50% of your capital back, your down 50%. If shares will you be paid dividends?

Will you be relying on the company having an Initial Public Offering, or being brought out by a larger company some time in the future?

Typically, an investor would hold their investment for at least five years. In some cases only three or up to 7 – 10 years. The returns have to be substantially high to compensate for the opportunity cost and the risk vis a vis less riskier assets. The returns must still be realistic.

It’s worth your time speaking with the directors of the venture and going through these points with them. They are the ones with the idea. They should be able to articulate them. Also, having a second opinion perhaps with your accountant or financial adviser but only if they are experienced in this area, otherwise their opinion is as good as the Man on the Clapham Omnibus.

Certainly, the amount you invest plays a big role in mitigating your risks. Being too conservative will hinder your ability for real gains but being too greedy is the number one reason why Private Investors fall flat on their face.

Once you have a simple formula you can refine and improve it going forward, it will help you take out the stress in having to make important decisions, that have profound outcomes.

As my old Sergeant used to say:

“Time spent on reconnaissance is time well spent!”

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