Investing in private companies can be rewarding. Many people tend to think of investments as investing in the stock market or purchasing a property for rental yield or capital appreciation. However, making your money work harder for you may mean thinking out of the box and in this blog post, I am going to speak about investing in private companies.
Private companies are basically companies that are not listed publically. In general, most of the time, when someone wants to start a company for a certain business, he will start a private company. In Singapore, it does not cost much to set up and maintain a company. Companies can be formed for a variety of business activities. They can range from companies that run restaurants, retail, provide medical services to companies that deal with consultancy services like accounting and legal services to even companies that deal with cryptocurrencies, trade stocks and purchase and manage properties. In short, if you want to do business in Singapore, it would be good to set up a separate entity to do so.
To understand how we can invest in private companies, we need to learn how private companies are formed and how they are structured and managed. For the explanations in this blog post, I will try to use as few technical terms as possible and try to use layman terms. The most common structure would be to set up an exempt private company limited by shares. This would mean that the liabilities of the company are limited to what the value of the shares are worth and the paid-up capital or whatever monies are in the company. Thus, if the company has 100,000 shares and each share is worth $1, the maximum liability that this firm is liable for is supposed to be $100,000. When the company is formed, the shareholders are supposed to place this $100,000 into the bank account of the company. This $100,000 is then used to run the company. It can be used to pay rent, purchase equipment or pay salaries. All accounting must be accounted for. To ensure this, the Accounting and Corporate Regulatory Authority of Singapore (ACRA) makes it mandatory for an Annual General Meeting (AGM) to be held every calendar year. There are penalties for not adhering to these standards. In short, there are checks and balances in place and companies have to adhere to the Companies Act. Enforcement, in my opinion, is sporadic mainly because of the sheer number of companies that are set up. It would not be possible for ACRA to police and audit every single company in Singapore. Thus the question is, how do we know what company to invest in and how can we do our own due diligence to ensure that the company is well run.
1) Good management
This is a very broad term but it would be good to start by understanding the management team of the company. This is something you should do whether you are investing in a public listed or private company. For private companies, you may have the chance to interact with them personally. For example, you may be wanting to invest in your friend’s food and beverage (F&B) company. You should know the people managing the company. The directors, officers, managers should be capable and trustworthy. Sitting down and speaking with them should be the first step in your due diligence process. You should also try to do profile searches on these key appointment holders.
2) Take a look at the financial statements
Every company should have financial statements prepared for every AGM. These financial statements should have information like the statement of financial position, statement of comprehensive income, statement of changes in equity, statement of cash flows, director statements and notes to all these statements explaining clearly the basis of how these numbers were derived. Usually, these statements are unaudited as most small companies do not require their statements to be audited. Even so, these financial statements will clearly tell an investor the financial position of a company.
3) Take a look at the bank accounts
The bank account of a company will tell an investor if there are proper checks and balances in place and whether money management is done correctly. Monies should be properly accounted for and whenever possible, there should be more than one person signing of cheques and making internet banking payment instructions. The bank account should accurately reflect the balance as stated in the financial statements. In cases whereby the private company is really small like a one or two man set up, the bank account may be in a mess just because the person running the business may handle monies in the most convenient manner and not in the manner which reflects the best form of corporate governance. If so, there should still be a record of all monies received and spent for the entire duration of the company’s operation.
4) Observe the business
Many people want to get into a business without understanding the business. There are many people who tell me that they invested in their friend’s F&B establishment or retail outlet and are mere sleeping partners. Well if you want to be a sleeping partner, do not cry foul when things go awry. To invest in a private company you have to understand the business. Spend some time sitting in the company’s place of operation to take a look at the daily running of the business. If you are astute, you can pick up reasons for and against investing in the business. Also, you can project estimated returns by taking a look at how the company is run.
5) Analyse the business model
Remember this, if the business is asking for external funding, it is doing so because of a lack of funds. This can happen because it wants to expand or it is not doing too well and would need to burn more cash to establish a foothold in the market. No self-sustaining business would want to receive monies in exchange for shares as this would mean having to answer to new shareholders. The business model must be sustainable and it must make sense to you for you to invest in the company.
6) Take a look at the pitch deck (if available)
Usually, there would be a pitch deck if a company was seeking investors. The pitch deck should be given to you to study. It should show projections and state clearly how monies received from investors is to be used. You should be able to know how much they intend to pay the directors and management team, how much will be spent on marketing and inventory as well as other miscellaneous items. Take note of figures that do not make sense like a very high wage bill in the projection figures or an exorbitant amount on inventory. You should question any figures which may seem excessive.
7) Hire professionals to get a second opinion
You should seek advice from people who are familiar with investing in private companies as well as seek legal and accounting advice if you do not understand any portion of any legal document or financial statement. Every company should have a secretary and in most cases, the company would have appointed a corporate secretary. The files which include important company documents and registers is kept with the corporate secretary. You can request to take a look at the company files and you should question the corporate secretary if you would like to have more information about the company. The corporate secretary, with the instruction from the director or controller of the company, will furnish the information to you if permitted.
8) Suggest changes before investing
Every company has a constitution. The constitution states how the company should be governed. Before you invest in the company, you can suggest changes to the company’s constitution or company structure. You should be comfortable with the share type that you are receiving in exchange for your money. Do note that a company has the right to issue new shares, issue different classes of shares or sell shares to investors other than you. You should know what circumstances these can happen and under what authorisation. You do not want to be in a position whereby your shares in a company are diluted to a point whereby returns are not viable.
Investing in private companies can be tricky. There are many companies out there looking for investors for one reason or another. In some cases, investors have been known to have lost their monies by investing in failed companies. Basically, these are business ventures gone wrong. When done correctly and with proper analysis and understanding of the business model, there are many investors who have invested in private companies and obtained very healthy returns. I personally have heard of investors investing in private companies and quadrupling their investment in a short space of time. I have also heard of people investing in companies whereby mismanagement caused them to lose their investment. I do hope that my pointers do come in useful the next time someone comes along and asks if you are keen to invest in his company or get into a joint venture.
Yours Sincerely,
Daryl Lum
I personally own a corporate secretariat firm and we are a registered Filing Agent (FA) with the Accounting and Corporate Regulatory Authority of Singapore (ACRA). I am a Qualified Individual (QI) under the FA. You can visit the firm’s website at https://singaporesecretaryservices.com/. We handle corporate secretariat matters, incorporation of local and overseas companies, mergers and acquisitions, investments in and valuation of private companies. This article was written to give a better understanding and hopefully provide a basic checklist before investing in private companies.
