With the turmoil of the stock market and the advent of large blue chip companies failing and event real estate faltering….risk vs reward takes on a whole new meaning. Private Equity Investing in early stage companies has long been considered the most risky of asset classes to put money into. However, it has proven historically, even in the market collapse of the dot-com era, to be the investment class that produces the greatest return on investment. Angel investors historically get better returns than even VCs or the big Private Equity Funds you hear so much about. Why is that?
Angel Investors tend to get better returns because they invest when the company has the lowest valuation. The stock they buy may be less then $1 a share, and yes although you can purchase stocks on OTC BB or even the regular exchanges at less than $1 a share, that is usually becuase of some decline in value. Early stage companies that are currently valued at less than $1 a share have all the promise of massive increase in valuation. If they are starting out at 50 cents a share, and then get purchased at a modest valuation years from now at $5 a share, that is 1000% gain, or even if they do what most regular public companies go public at greater than $10 a share…presto big return. Enough to make up for the 3 or 4 that went belly up….that is the risk part of the reward.
So how can you mitigate risk when making an investment in private companies? There are 4 key areas:
- Intellectual Property Protection – patents, copyrights, trademark, trade secrets
- Management Team/Advisers – experienced management from within or recruited from outside
- Insurance – key man insurance, errors & omissions, other corporate insurance
- Strategic Planning – what will they exactly do once they have their funds
- Sales Validation – do they have the sales team/strategy that can achieve the expected results
- Terms of Investment – small terms may have big impact on the angel investor down the road
- Market Validation / Competition – having sold something or having market validation in a pipeline, joint venture, or in improving on the competition go a long way to validating the opportunity
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