My Three-Step Process to Review a Private Investment

As an investment advisor, clients often ask my opinion about a private deal they’ve been offered. You may be called upon to do the same. These deals vary from angel investments in start-up companies (pre-venture capital) to large rounds of capital for positive-cash-flow deals like a private real estate investment.

Here’s the general framework of how I assist the client in reviewing such investments. Understand that they come to me with the opportunity; I don’t recommend any private deals.

For starters, I advise the client that private markets are not as efficient as public markets (stocks). Private deals can be incredibly lucrative, but also turn out to be total losses. The first thing I tell the client is that I’ve seen far more poor to awful results from clients. The second thing I tell clients is that there is far more money in the private equity space and that drives up the market efficiency and drives down the return. In fact, I’ve had several general partners of private equity firms tell me that there is too much money chasing too few deals. Indeed, the coronavirus-induced market stress will be particularly challenging for private deals, especially those with high leverage.

While not remotely statistically meaningful, I’ve made two private investments over the years – one was close to a complete loss while the other had about a 12x return over a few years when the company was acquired. Before becoming an investment advisor, I assisted a few firms in writing private placement memorandums (PPMs) that accompanied the investment proposal sent to accredited investors with either joint annual net income of $300,000 or a net worth of over $1 million. There are some other qualifications as well, but I suspect most of our clients are accredited investors.

For the review process below, I’m referring to arm’s-length deals, rather than deals offered by friends and family. If I’m asked about the latter, I merely point out that if the deal goes sour, it could strain the relationship between the friend or family member. I recommend the client invest at most 20% of their net worth in these deals, as they are inherently risky and illiquid.