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When most people talk about investing, they’re referring to public markets, where share prices are published every day, and shares can be bought and sold at the touch of a button. Private companies don’t fit that model, and for many investors, that’s not only exciting, it’s also complicated.
The bare truth is that most ways of investing in private companies are off-limits. You have to be accredited, commit substantial amounts of capital, or gain access to specialist platforms that aren’t open to all. It’s better to know this in advance rather than look for investment opportunities only to find they’re off-limits.
The McKinsey Global Institute reports that private markets have flourished in the last 20 years, with trillions of dollars in assets under management globally in private equity and venture capital. All these illustrate the importance of this part of the investment industry, even for those who haven’t invested directly in private markets.
Quick Answer
- Private companies don’t have shares listed on exchanges; their shares are not freely traded and cannot be purchased through a brokerage firm.
- Most private company investment routes usually involve accredited investors or institutions.
- Primary options include private equity, venture capital, angel, crowdfunding, and pre-IPO secondary markets.
- There are varying levels of access, minimum investment amounts, and risks for each route.
- The risks involve illiquidity, valuation risk, information asymmetry, and long time horizons.
- Equity crowdfunding is usually the easiest path for non-institutional investors, but it is still risky.
What Does It Mean to Invest in a Private Company?
Investing in a private company means [1] getting exposure through CFDs, a stake in a company whose shares are not traded on a stock exchange.
CFDs on public companies’ shares can be traded by eligible traders through a brokerage or trading account, during market hours, based on publicly displayed, constantly changing underlying share prices.
This is not the case with private companies. Their shares are owned by a small number of shareholders (the founders, workers, and investors who’ve taken part in certain funding rounds), and the owners must take active steps to transfer shares, rather than simply buying or selling.
This affects almost everything: how you value the investment, how you get out of the investment, what information you get, and how long your money could be tied up.
Investing in private companies is not better or worse than investing in the public markets; it’s just different, with different rules, different risks, and different access restrictions.
Who Can Invest in Private Companies?
Investing in most private companies requires meeting the definition of an “accredited investor,” a regulatory standard aimed at ensuring investors can handle investment risks.
Most countries define accredited investors by a combination of income and net worth tests, and professional experience. The numbers vary across jurisdictions, but the principle remains the same: private investments are risky; they are illiquid, have limited public information, and their valuations can be unclear. Regulators believe those risks are suitable only for investors able to sustain potential losses.
Private markets aren’t totally off-limits to non-accredited retail investors. Equity crowdfunding was created to provide a regulated avenue for retail investors. However, most of the avenues for investing in private companies are off the table for non-accredited retail investors.
The first step is to determine which category you fall into because the options available to you depend on it.
What Are the Main Ways to Invest in Private Companies?
There are a number of ways to invest in private companies, each with its own criteria for getting into a deal, the size of the investment, level of risk, and time horizons.
Private Equity Funds
Private equity funds raise capital from a number of investors and invest in private companies, often with an aim to improve the companies and sell them or take them public. Investing in private equity funds is a way to invest in a fund rather than picking individual companies.
Typically, only institutional and accredited investors who meet minimum investment requirements can invest. The time horizon is typically long, like a period of 10 years or more; once the money is committed, it cannot be withdrawn.
Private equity funds are active in managing their portfolio companies, taking board seats, and effecting changes to their operations. This is another reason why private equity is different from buying shares in a listed company.
Venture Capital Funds
Venture capital is investment in early-stage and growth companies, often high-tech or innovative firms with high growth prospects. Venture capital funds are similar to private equity funds in that they pool the capital of investors, who leave portfolio investment decisions up to a group of professional investors.
Investment is typically only open to institutional investors and high-net-worth individuals, and the investment risk is greater than mature private equity, because early-stage companies can be riskier investments, as well as offering greater growth.
A single venture capital fund will often invest in dozens of firms, with the understanding that the few successful results need to support the entire return.
Angel Investing
Angel investing is direct early-stage investment in a business, in return for equity, on behalf of the individual rather than a fund. Angels are most often early-stage investors, prior to other institutional capital.
This type of investing typically requires accreditation, risk tolerance, and the ability to judge the quality of early-stage businesses without the financial information available with more established businesses.
Example: An experienced technology professional invests a small proportion in three early-stage software companies as an angel investor. After a few years, two businesses fail to generate any returns. The third grows rapidly and is bought out, producing a return that compensates for the losses on the other two.
The result was good, but it meant having the capacity to afford to lose 100% on two-thirds of the investments without financial setback. This is a key requirement for angel investing.
Equity Crowdfunding
Equity crowdfunding enables retail investors to access shares of private companies through regulated platforms, often with lower minimum investment thresholds than other avenues in private markets.
Unlike donation-based crowdfunding, equity crowdfunding offers real equity shares; investors receive shares and participate in the gains (or losses) of the company.
Many jurisdictions’ regulatory frameworks have established rules for the operation of the platforms and disclosure for the companies, giving more certainty than private markets, but still with substantial risk.
Pre-IPO Secondary Markets
Secondary markets allow investors to trade shares of unlisted companies, not during a company’s funding rounds. An investment in a pre-IPO company through these platforms is a purchase of shares from a current shareholder, instead of shares issued by the company.
This investment typically requires accredited investor status, large minimum investment sizes, and the shares are illiquid (there is no market to sell the shares until a liquidity event).
The CFA Institute suggests that secondary market transactions in private companies are one of the fastest-growing segments of private markets, driven by a desire to invest in prominent private companies before they go public.
What Are the Risks of Investing in Private Companies?
Investing in private companies isn’t risk-free, but the risks differ from investing in public markets.
- Illiquidity: Private investments can’t be sold freely; you may be investing for many years with no exit strategy.
- Information asymmetry: Private companies don’t have to produce the same financial reports as their public counterparts, so it is more difficult to assess.
- Uncertain valuations: Without an ongoing market price, valuations are based on negotiation, not a clear market value.
- Dilution risk: Subsequent rounds of funding can create new shares that decrease the total ownership of existing investors.
- Long investment horizons: The returns from private investments are long-term (if they are ever realized)
- Loss of capital risk: Private companies, especially early-stage companies, can go out of business, giving investors a zero return.
How Is Private Company Investing Different from Public Markets?
The differences between private and public markets affect all aspects of investing, from access to opportunities, investment management, and exits.
Public markets have continuous liquidity, transparent prices, standardized financial disclosure, and regulatory oversight to protect retail investors. You can trade anytime the market is open, and exit at your own convenience.
Private markets have none of these attributes. Entry is limited, there is no continuous pricing, limited disclosure, and exit depends on an event, which could be a sale, IPO, or secondary listing, that may not occur at a predictable time.
The potential trade-off is growth. Private markets can provide exposure to the growth of the business prior to listing, where a lot of value creation occurs. But such potential comes with illiquidity, information disparities, and risk of loss that public market investors are largely protected from by regulatory structure.
Frequently Asked Questions
In limited ways. Equity crowdfunding provides the best option for non-accredited retail investors. Other methods tend to be for accredited investors or institutions.
Private equity often invests in later-stage, private companies, often gaining control and managing them. Venture capital invests in early-stage startups with the potential for rapid growth but also a higher risk of failure.
An accredited investor meets specific regulatory guidelines on income, net worth, and professional qualifications. Accredited investors are allowed to invest in most private investment opportunities due to the risks. Different jurisdictions have different criteria.
Platforms provide regulated access for private companies to investors for smaller minimum investments than other private market avenues.
A secondary market provides a way for shareholders in a private company to sell their shares to a new investor before the company has a liquidity event. Investors must be accredited and have a high minimum investment threshold.
It varies significantly. Private equity and venture capital investments are often a ten-year-plus commitment. Angel and pre-IPO investments are dependent on the timing (and occurrence) of a liquidity event.
In the absence of a liquidity event, there may be no way for investors to recoup their investment. In the worst-case scenario of business failure, the investment may be lost, one of the biggest risks of investing in private companies.
Yes. Private companies can go bust and not return any money to shareholders. Capital loss is an inherent part of investing in private companies, especially in early stages.
Final Thoughts
Investing in private companies isn’t impossible, but it is not easy. The channels are available, they’re employed by savvy investors around the world, and some of them have been made accessible to the public through equity crowdfunding structures.
What they have in common is a need for an informed consideration of the trade-offs: loss of liquidity for growth prospects, reduced information for early entry, and long holding periods for the chance of high returns. None of these trade-offs is necessarily bad, but they shouldn’t be made without knowing what you’re getting into.
Start with the eligibility question. Then the access question. Then, and only then, is the investment question.
Risk Disclaimer
This is educational material only and should not be considered investment advice. Investing in private companies is risky and may result in the loss of the entire investment. Private investments lack liquidity, are prone to valuation risks, and can have long holding periods with no return on investment. Investors should carefully consider their own investment objectives, financial resources, and risk tolerance before investing.
CFD Risk Warning:
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You may lose more than your initial investment. You should ensure you fully understand how CFDs work and consider whether you can afford to take the high risk of losing your money.
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