Investing in private companies: Should stock market investors consider this or is it too risky?

Nick Sundich Nick Sundich, June 23, 2023

The advent of investing platforms such as OnMarket and Birchal have made investing in private companies as easy as listed stocks.

But while getting in may be a piece of cake, getting out…well, not so much.

 

 

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Why you might consider investing in private companies?

Obviously you should be investing for the right reasons, not just because you can. Just ask some of victims of disasters such as Xinja that raised capital from retail investors but caused significant investment losses when it went belly up in 2020.

 

 

But not all private companies that raise capital are bad companies. In fact, many public companies began as private.

By investing in private companies, investors able to access more lucrative financial opportunities than those available on the public markets. Private companies can be attractive to investors since they can offer higher returns and faster growth rates due to a lack of competition from other market participants.

Furthermore, although private firms are less liquid, it means they are often less susceptible to market fluctuations caused by macroeconomic events – at least in the short term. This means that investors can enjoy more stability in their investments, at least in theory.

However, the recent example of Canva depicts that prolonged market downturns may lead to investors having to write down parts of their investments in private companies due to market forces, even if demand for the company’s products and services remain solid. 

Nevertheless, it is a fine line between a Tech Wreck of several months versus a one-day crash in the market driven by a geopolitical event on the other side of the world such as Brexit or Russia’s invasion of Ukraine.

 

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But consider the risks

Of course, there are also potential risks associated with investing in private companies. Some of these are common to listed companies too, others are unique risks that listed companies do not face. 

For instance, there may be limited liquidity in such investments and difficult exit strategies for any money invested. Additionally, many private firms do not have stringent disclosure requirements or external oversight which could result in the mismanagement of funds or a lack of transparency into their financial results. Finally, it is important for investors to understand that there are extra costs associated with investing in a private company beyond just the purchase price of stocks—such as legal fees and due diligence costs—which could reduce any potential returns from such an investment.   

 

So should you or not?

Ultimately, whether stock investors should consider investing in private companies generally depends on their individual risk appetite and goals as an investor.

However, done correctly and with proper research and planning beforehand, investing in a privately held firm has the potential to reward investors with strong returns and provide them with access to opportunities not available on public markets. 

Of course, the question of whether or not to invest in a specific private company are entire different topics altogether!

 

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