How do I make money from a private company investment? Aside from the other benefits of investing in early-stage businesses, we understand that visibility on how you make a return is still key.
There is uncertainty when it comes to making money from any investment in a company but even more so with ones not yet listed on the stock exchange.
This is because equity crowdfunding investments are relatively ‘illiquid’ (meaning you can't easily sell your shares) so a return can’t be made until what we call an ‘exit event’ occurs whereby you can sell your shares. However, High School economics teaches us that with greater risk, comes greater returns, generally. It’s the same principle here. Early-stage investing is usually seen to be riskier than investing in more established businesses as there are a lot more unknowns however because you’re getting in on the ground floor, there can also be higher returns.
So how do you actually make money off these investments?
There are a range of different ways investors can potentially earn a return on their investments. Here’s a quick breakdown of the options:
IPO: An initial public offering, or float, is one of the more common and better known exit opportunities. Generally once a company reaches a certain size, they may wish to raise a larger amount of capital, and provide their shareholders with a way to exit their investment. In Australia this usually takes place through the ASX, while in New Zealand its usually through the NZX. The company offers a new set of shares to investors, and in doing so also becomes a public listed company on the stock exchange. This means that existing shareholders and interested parties can buy and sell their shares relatively easily, for a market determined share price. But not all private companies want to go public, so what are the other options?
M&A: We’re sure you’ve seen this combo of letters before but what does it actually mean for you and your bank account? M&A stands for mergers and acquisitions, representing the range of business transactions that can occur between business entities, both private and public. A merger is where two businesses combine into a single entity, often so they can benefit from greater scale and work together. An acquisition is where another entity purchases a majority stake in the company and takes control. When this occurs, the impact on you can vary slightly depending on your shareholder agreement, but generally you will have an option to sell your shares in the transaction, and usually this is a good thing, as the company making the acquisition will have to pay a premium on the share price to complete its transaction.
Share Buyback: A company might back itself to such an extent that it wants a greater degree of exposure to its own growth. In this scenario, management would facilitate an offer to purchase shares from existing shareholders at a determined price level. This provides investors that choose to take the deal an opportunity to exit their investment.
Dividends: Distributions of company profits aren’t only limited to public listed companies. If a private company is profitable it may elect to return a proportion of these profits to its shareholders on a regular basis. Shareholders still maintain their holding of the company and receive dividend payments reflecting their share of company profit. Generally this happens later in a company’s lifecycle where it no longer needs to reinvest all profits into growth.
Private Secondary Market: The ASX or NZX are examples of public secondary markets where existing shares can be traded between buyers and sellers. Private secondary markets allow private company shareholders to exchange shares between one another should they elect to exit their investment, or desire to increase their holding. Whilst this option is not available right now, we anticipate it will be soon.
Off Market Transfer: Similar to a private secondary market but in a more manual sense, if two individuals decided to make an exchange of a shareholding and cash, they can do this privately in accordance with their relevant shareholder agreement.
We advise four key things:
- Only invest what you can afford to lose.
- If you can, invest in early-stage companies as a way to diversify your portfolio. Even out the risk, but also maybe the return, by investing in more established businesses as well.
- Do your research. You can be sure we do ours, but it’s still important you understand the business you are looking at investing in, which is why there is a comprehensive offer document.
- Be prepared to be in for at least the slightly-longer term. These investments are not yet liquid and it can take several years before you might realise a return.
But enough with all the doom and gloom, here’s why you might want to get involved in an early-stage business:
- Return on investment might be greater as you’re getting in on the ground floor when share prices are low. Imagine investing in the next big thing right from the get go (sure beats 2% p.a. on a standard savings account!).
- Investment is accessible starting from around $250, which is a nice break from other investment opportunities at the moment and allows you to diversify.
- It’s also exciting being given the opportunity to become a co-owner in a business you’re passionate about. So far all of our companies have chosen equity crowdfunding because they want ‘the crowd’ around them, drawing on those shareholders for advice and feedback on new products etc.
- Private company investment is a great way to diversify your portfolio. It can provide protection from market forces that might impact on public shares, and this super low interest rate environment we’re currently in.
- Support something important! A lot of the companies we work with are doing genuinely amazing things for the world whether they’re disrupting their industry, helping to save the environment or providing opportunities to those in need. You can put your money towards a positive outcome with some of our clients.
Given the relative youth of the equity crowdfunding industry, and standard early-stage company timeframes, it’s unsurprising that we’re yet to see many exit events resulting in a return on investment. What we have seen is a lot of success so far from the companies we’ve raised for. Several of our portfolio companies have experienced uprounds, which is essentially an increase in their valuation or share price. You can read more about the 2018/19 uprounds, and their average share price increase of 109%, here.
Nonetheless, we can take confidence in the success of international equity crowdfunding markets that have existed for several years longer than ours. Not only are these markets seeing ongoing growth, higher amounts raised, and greater attention, they have also started to see exit events!
Here are three examples of exits from UK equity crowdfunding platform Crowdcube (Crowdcube has been raising capital through crowdfunding for several years longer than we have, owing to the UK’s earlier regulatory shift):
Camden Town Brewery: One of London’s biggest breweries raised £2.75m back in 2015, and was privately acquired just 8 months later, providing investors with an undisclosed multiple return on their investment.
Revolut: The neobank has offered two exit opportunities in 2016 and 2018, with investors receiving a 19x return on their original investment at the later exit. These two opportunities have provided a return of £1.76m to investors.
Mettrr Technologies: From a 2012 raise, investors in April 2017 realised a 9x return on their original investment through a secondary share sale through Crowdcube.