As a minority business investor, it is essential to have an investment strategy that will maximize your returns. Once an investment decision is made, it is critical that a target business will enhance value of a broader investment portfolio. At the same time, many minority investors are also business owners who know what makes for a successful enterprise. This post is a discussion of what minority investors should look for in a privately held business.
Since a minority investor has a significant but non-controlling ownership interest in a business, the first rule of thumb is to invest in business enterprises that you understand and with which you are comfortable. At the same time, great investments can also be found outside your business comfort zone provided that you have good management skills and the acuity to understand your target’s business model.
Investing in a small business starts at the top, that is with the owners. Accordingly, getting to know the owner and understanding how they do business is critical in your decision-making process. One key attribute you should look for in an entrepreneur is passion. Without it, he or she will lack the vision to steer the company toward success. It is also wise that you exercise caution by conducting background checks particularly with an eye toward ascertaining any legal actions in which the owner and other key people have been involved.
Of course, it’s not only a matter of the people, it’s about the numbers. The onus is on you to do your own due diligence, perform your own research and undertake an analysis of the proposed business plan. An investment proposal can be filled with numbers that amount to nothing more than smoke and mirrors. It’s your job to ensure the numbers add up.
Once you’ve done your homework on the target business, you need to decide how much to invest and how closely you will be aligned with the entity. Determining how much to invest is really a matter of risk management. In order to safeguard your investment, it is critical to negotiate a deal that is mutually beneficial. In particular, you should consider having an exit strategy with an understanding that your investment will be repaid by a certain date at an agreed upon rate of return.
You must also decide whether you will have no active participation in the decision-making and operations of the business or if you will be involved in the management of the entity. Even as a minority investor, your stake in the business may be significant enough to warrant having a seat at the table in order to advise on policy and evaluate management’s performance.
As a minority investor, there are many business categories to consider that depend on your investment strategy. For example, investing in a start-up tends to be high-risk since management may not have a track record of success or a proven business model. Nonetheless, start-ups can also offer great rewards if they are breaking ground in a new business method or technology. The caveat is that the majority of start-ups are short-lived and destined for failure within the first 5 years.
If you are looking for a growth opportunity, there are business enterprises that have successfully launched but need another infusion of capital to grow. These businesses have an initial track record that will allow you to determine if your investment will be rewarded, even if it is subordinated to original investors. On the other hand, opportunities can also be found in companies that have stopped growing because of insufficient capital but still have a solid business plan.
For investors with a greater appetite for risk, companies that are failing can be ripe for a turn- around, provided that your stake comes with a hand in the decision-making and that the business fundamentals remain sound. Even bankrupt entities with cash flow potential offer investment opportunities for investors who are willing to have a high level of involvement.
For the minority investor, the nature of investing is high-risk, and every opportunity is unique – some offer greater rewards as well as higher risks. Your ability to make a decision on the merits of a business plan depends on your capacity to be a good business manager as well as a shrewd dealmaker. Investing in a privately held business requires a lot of up-front sweat equity in researching your target company, analyzing financial reports, evaluating the businesses track record, and ascertaining management’s skills.
In particular, investing in a closely held business is an investment in the owners as well as the business. These entrepreneurs need to be innovative and have the ingenuity and passion to grow the business. In the final analysis, investors and owners need to be honest partners and strike a deal that is a win-win. The goal for both parties is to ensure the enterprise is successful and offers a worthwhile return on investment.
If you do your homework, your investment in privately-held businesses can be quite lucrative. That being said, it’s always in your best interest as a minority investor to have a lawyer on your side of the table to craft an investment agreement, advise you of your responsibilities and shield you from potential litigation.