Investing in a private company can offer exposure to a business at an earlier stage of its growth. It also involves less information, less liquidity and more uncertainty than investing in a listed company. A structured approach to due diligence helps investors understand what they are committing to.

The business

Start with the fundamentals of the company itself:

  • What problem does the business solve, and for whom?
  • How does it make money, and is revenue recurring?
  • Is it profitable, or how long can it operate on its current funding?
  • Who are its competitors, and what differentiates it?
  • What are the biggest risks to the business model?

The people

In private companies, management and the board play an outsized role. Investors commonly look at the experience and track record of founders and directors, how much of their own capital is invested, and whether governance arrangements are appropriate for the company's stage.

The valuation and terms

Private company valuations are often set by negotiation and can be difficult to assess. It is useful to understand how the valuation was determined, how it compares with similar businesses, and what rights attach to the shares being offered. Different classes of shares may carry different rights on dividends, voting or a sale of the company.

Investors should also understand the potential for dilution — future capital raisings may reduce their percentage ownership — and whether any protections apply.

The exit

Private company investments generally become liquid only through an event such as a trade sale, a listing or a share buy-back. Understanding the intended exit pathway, the realistic timeframe and what happens if that pathway does not eventuate is a critical part of due diligence. Investors should be prepared to hold the investment for an extended and uncertain period.

The documents

Read the offer documents, constitution and any shareholders' agreement carefully. These set out transfer restrictions, information rights, pre-emptive rights and other terms that affect the investment. Where documents are complex, independent legal and financial advice can be valuable.

This article is general information only. It is not a recommendation to invest in any private company.