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  • Question regarding preferred investing

    Hello all-

    I am hoping to tap into your collective wisdom. I am trying to decide whether to initiate a position as a preferred investor in a private company with plans to go public within a couple of years. The minimum investment is not small (IMO).

    I am a practicing doc 5 years out of residency. I am currently invested in 100% equity index funds with 25% international and a slight domestic tilt toward small value.I am not an accomplished investor beyond reading WCI and Bogleheads forums. My investment strategy to this point has simply been to buy and hold index funds until retirement. I guess I am trying to accelerate my net worth by considering this. My buddy tells me that it is a no-brainer and a great opportunity FWIW.

    My questions are: (1) Do any of you have experience with this type of investment? (2) What are the primary considerations when evaluating this type of investment? (3) Can I use money from my (and my spouse's) Roth IRA to do this?

    Any and all help is much appreciated. Thanks.

    Jimmy

  • #2
    If you don't have the training to estimate the value of a prospective investment, then you are out of your depth.
    Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

    Comment


    • #3
      There is not any "no-brainer" in investing. You are currently following a reasonable - actually excellent - plan, at least for investing (which is nothing close to a real financial plan). There are no shortcuts to growing wealth except through blind luck. Investing in a private startup is just that. You may get lucky. It is far more likely you will lose your investment and/or be trapped in the quicksand of illiquidity for many years to come.

      Let your buddy be the guinea pig and tell us how it turns out in a couple of years.
      Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

      Comment


      • #4




        Hello all-

        I am hoping to tap into your collective wisdom. I am trying to decide whether to initiate a position as a preferred investor in a private company with plans to go public within a couple of years. The minimum investment is not small (IMO).

        I am a practicing doc 5 years out of residency. I am currently invested in 100% equity index funds with 25% international and a slight domestic tilt toward small value.I am not an accomplished investor beyond reading WCI and Bogleheads forums. My investment strategy to this point has simply been to buy and hold index funds until retirement. I guess I am trying to accelerate my net worth by considering this. My buddy tells me that it is a no-brainer and a great opportunity FWIW.

        My questions are: (1) Do any of you have experience with this type of investment? (2) What are the primary considerations when evaluating this type of investment? (3) Can I use money from my (and my spouse’s) Roth IRA to do this?

        Any and all help is much appreciated. Thanks.

        Jimmy
        Click to expand...


        A private company is not a place/situation to invest in.  Evaluation of private firms is usually that much more difficult because of weaker accounting/controls relative to publicly traded firms.  The evaluation part more difficult when the company is not profitable and going for 'growth'.  Unless you have another (beside money) particular expertise that you can bring to the table (for instance medical instruments), I would stay away from this opportunity unless you set the expectation going in that you will lose every dollar you 'invest'.  There is a pretty good financial advisor, Allan Roth who has a saying on his website 'Dare to be Dull' which applies here.

        Comment


        • #5
          It's not a "no-brainer", but I also don't think opportunities like this should be automatically turned down.  I think there is a place in a portfolio for speculative or non-index investments.  That said, it's a pretty small place, like maybe 5%, and it shouldn't all be in one investment.  For example, if you have a portfolio of $1M, I could see investing $5-10k in a situation like this.

          Regarding this specific situation, most likely the IPO will never happen, and you will be lucky to ever see any fraction of your money back.  These situations can be intellectually rewarding even if you don't ultimately invest, so I would go ahead and kick the tires if I were you.

          • Ask for monthly and annual financials (income statement, balance sheet, and cash flow statement) and ask if there are audits (probably there are not).

          • Ask for tax returns.  No one overstates income on a tax return.

          • Figure out if the company is burning cash or if it is profitable and able to support its operations for the next 12 months without raising other money.

          • Ask for a written business description and any materials they have prepared for this capital raise or prior ones.

          • Ask for the resumes of the management team.  Figure out if they have relevant experience based on the resumes.

          • Ask for a capitalization table showing debt, equity, and preferred with ownership breakouts both prior to the investment and pro forma for the investment.

          • Ask about the valuations of any prior investors.

          • Ask why the company is raising money, i.e. what will be the "use" of the funds.  Also find out what the sources of cash are other than your investment.

          • Ask for the terms of the preferred (how much cash pay, how often, what is the liquidation preference, term) and ask and ask about the tax implications to you.

          • If there is cash pay on the preferred, do a little math to figure out if the company can support making that preferred payment.


          Anyway, I think it is unlikely that you will ultimately want to do this, but I find these situations interesting.  If you decide to learn more, go in with a healthy dose of skepticism.  When you have a company with a short operating history and no audits, fraud becomes a real concern.

          Good luck!

           

          Comment


          • #6
            Wow you want to use Roth money on something you know nothing about?? Sit this one out man.

            Does your wife know what you are planning with her money?

            Comment


            • #7




              It’s not a “no-brainer”, but I also don’t think opportunities like this should be automatically turned down.  I think there is a place in a portfolio for speculative or non-index investments.  That said, it’s a pretty small place, like maybe 5%, and it shouldn’t all be in one investment.  For example, if you have a portfolio of $1M, I could see investing $5-10k in a situation like this.

              Regarding this specific situation, most likely the IPO will never happen, and you will be lucky to ever see any fraction of your money back.  These situations can be intellectually rewarding even if you don’t ultimately invest, so I would go ahead and kick the tires if I were you.

              • Ask for monthly and annual financials (income statement, balance sheet, and cash flow statement) and ask if there are audits (probably there are not).

              • Ask for tax returns.  No one overstates income on a tax return.

              • Figure out if the company is burning cash or if it is profitable and able to support its operations for the next 12 months without raising other money.

              • Ask for a written business description and any materials they have prepared for this capital raise or prior ones.

              • Ask for the resumes of the management team.  Figure out if they have relevant experience based on the resumes.

              • Ask for a capitalization table showing debt, equity, and preferred with ownership breakouts both prior to the investment and pro forma for the investment.

              • Ask about the valuations of any prior investors.

              • Ask why the company is raising money, i.e. what will be the “use” of the funds.  Also find out what the sources of cash are other than your investment.

              • Ask for the terms of the preferred (how much cash pay, how often, what is the liquidation preference, term) and ask and ask about the tax implications to you.

              • If there is cash pay on the preferred, do a little math to figure out if the company can support making that preferred payment.


              Anyway, I think it is unlikely that you will ultimately want to do this, but I find these situations interesting.  If you decide to learn more, go in with a healthy dose of skepticism.  When you have a company with a short operating history and no audits, fraud becomes a real concern.

              Good luck!

               
              Click to expand...


              I will bet you a dollar that the OP does not know how to examine financial statements (and has probably never seen any). It's also likely OP does not understand the relationship between debt, equity, and preferred shares.

              I mean that with no disrespect. Most physicians majored in biology or chemistry (or similar) in college, and had no accounting or financial training. If OP had enough knowledge to follow your advice, it's unlikely that he would have come here with this sort of post.
              Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

              Comment


              • #8
                @CM-  Even then experienced credit analysts/banks get burned by fraud or business condition causing cash flow shortages.  I've gone through two BK's of public companies, with one having to 'enforce' an unenforceable soft letter of comfort of the non-public parent after the CFO was doing some 'creative accounting'.

                Comment


                • #9
                  If you have money (outside tax-deferred retirement plans) that you can afford to lose, it might be worth considering, but only if you have the ability to evaluate the audited financials and know how to do so. If the deal is being offered by a "buddy" as a "no-brainer", on average, there is a very good chance that you are going to be taken and a small chance that you will make money on the deal. It is usually (but not always) wise to pass on such deals.

                  Over the course of your professional life, you will be pitched a number of "opportunities", from friends, colleagues, relatives, neighbors, and total strangers. There will be some winners, some losers, some legit deals, and some frankly fraudulent. What I ask myself when I (or a family member) is pitched is the following: if this is such a great opportunity, why do they want me in this deal? If I can come up with a good answer, such as my investment in imaging centers, I might (MIGHT) invest. If I cannot see the logic, I pass. While I may have missed out on a winner or two, I have also sidestepped quite a few losers.

                  Comment


                  • #10




                    @CM-  Even then experienced credit analysts/banks get burned by fraud or business condition causing cash flow shortages.  I’ve gone through two BK’s of public companies, with one having to ‘enforce’ an unenforceable soft letter of comfort of the non-public parent after the CFO was doing some ‘creative accounting’.
                    Click to expand...


                    I agree that even if the OP was an expert, his/her failure rate would likely be high when investing in early-stage private companies. They are difficult to value, even if the reporting is honest.

                    Jimmy should almost certainly stay away.
                    Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

                    Comment


                    • #11







                      It’s not a “no-brainer”, but I also don’t think opportunities like this should be automatically turned down.  I think there is a place in a portfolio for speculative or non-index investments.  That said, it’s a pretty small place, like maybe 5%, and it shouldn’t all be in one investment.  For example, if you have a portfolio of $1M, I could see investing $5-10k in a situation like this.

                      Regarding this specific situation, most likely the IPO will never happen, and you will be lucky to ever see any fraction of your money back.  These situations can be intellectually rewarding even if you don’t ultimately invest, so I would go ahead and kick the tires if I were you.

                      • Ask for monthly and annual financials (income statement, balance sheet, and cash flow statement) and ask if there are audits (probably there are not).

                      • Ask for tax returns.  No one overstates income on a tax return.

                      • Figure out if the company is burning cash or if it is profitable and able to support its operations for the next 12 months without raising other money.

                      • Ask for a written business description and any materials they have prepared for this capital raise or prior ones.

                      • Ask for the resumes of the management team.  Figure out if they have relevant experience based on the resumes.

                      • Ask for a capitalization table showing debt, equity, and preferred with ownership breakouts both prior to the investment and pro forma for the investment.

                      • Ask about the valuations of any prior investors.

                      • Ask why the company is raising money, i.e. what will be the “use” of the funds.  Also find out what the sources of cash are other than your investment.

                      • Ask for the terms of the preferred (how much cash pay, how often, what is the liquidation preference, term) and ask and ask about the tax implications to you.

                      • If there is cash pay on the preferred, do a little math to figure out if the company can support making that preferred payment.


                      Anyway, I think it is unlikely that you will ultimately want to do this, but I find these situations interesting.  If you decide to learn more, go in with a healthy dose of skepticism.  When you have a company with a short operating history and no audits, fraud becomes a real concern.

                      Good luck!

                       
                      Click to expand…


                      I will bet you a dollar that the OP does not know how to examine financial statements (and has probably never seen any). It’s also likely OP does not understand the relationship between debt, equity, and preferred shares.

                      I mean that with no disrespect. Most physicians majored in biology or chemistry (or similar) in college, and had no accounting or financial training. If OP had enough knowledge to follow your advice, it’s unlikely that he would have come here with this sort of post.
                      Click to expand...


                      I don't disagree with you.  Part of the reason for posting the list of items was to reinforce the message that if OP can't take the list , get responses, and then analyze them, then he would have no basis for proceeding to hand over his hard earned money to someone giving him a hard sell.  I should also point out that the list is the minimum necessary to start evaluating this deal.  Investing in individual companies is hard work, and it takes a lot of time.

                      All that said, the type of accounting knowledge needed is not so much that someone with  average IQ and time would be unable to figure out, even without formal training.  My view is that the best way to learn is with an actual, real world situation that forces you to understand.  If OP wants to learn about investing in a company, then this is as good of a place to start as any.

                       

                       

                      Comment


                      • #12


                        Part of the reason for posting the list of items was to reinforce the message that if OP can’t take the list , get responses, and then analyze them, then he would have no basis for proceeding to hand over his hard earned money to someone giving him a hard sell.  I should also point out that the list is the minimum necessary to start evaluating this deal.  Investing in individual companies is hard work, and it takes a lot of time. All that said, the type of accounting knowledge needed is not so much that someone with  average IQ and time would be unable to figure out, even without formal training.  My view is that the best way to learn is with an actual, real world situation that forces you to understand.  If OP wants to learn about investing in a company, then this is as good of a place to start as any.
                        Click to expand...


                        I agree with every word of this quote.

                        BTW, just read through some of your old posts. Good stuff. I hope you stick around the forum.
                        Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

                        Comment


                        • #13
                          OP here

                          Thanks for everyone taking time to reply. Your advisements of caution are well received. I do not have any formal business training, nor do I have experience reading financial reports.

                          To be clear, this opportunity was not one that I was pitched in an effort to rob me blind. It is a legitimate (start up) company with large institutional investors. My friend is an employee and mentioned that there may be an opportunity for an average joe like me to invest during the next equity round. I essentially sought this out, not the other way around. (I realize that does not necessarily make this a better investment opportunity.)

                          Of course I want to believe that this would be a great investment with high return potential in a few years. I do have access to financials and have a few months to consider them.

                          Regarding investing within a Roth, why would this type of investment not qualify as a valid redirection of my current investments within the Roth?

                          Does anyone have any direct/personal experience in investing in highly speculative businesses/companies/stocks that resulted in huge gains or losses?

                          Thanks again for the discussion.

                          Comment


                          • #14
                            I have posted my story before.  My experience was extremely bad.  At one time I belonged to an Angel Investing group.  There are lots of tech start ups in my community.  Deals were pitched every monthly meeting.  Financials were presented. The bios of the founders were presented.  Due diligence was done by a committee for each investment etc.  The deal was to manufacture a new type of incubator for neural tissue. The inventor had a PhD from Harvard.  I invested.  The founder walked into a room at the local University and killed several people because she was upset about being denied tenure.  Investing in startups is inherently risky in ways you cannot predict. The company eventually bankrupted and I had a tax loss.

                            Comment


                            • #15


                              Regarding investing within a Roth, why would this type of investment not qualify as a valid redirection of my current investments within the Roth?
                              Click to expand...


                              Yes, you can invest in this company using your Roth IRA. You could not be directly involved in any way with the enterprise (such as sitting on the BOD) or you would run the risk of blowing up the Roth's protected status, which is what I think @Rex may have been talking about.
                              Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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