Understanding Risks in Private Placements
Introduction
On a recent episode of the Direct Private Investments Show, we dove into a discussion with industry experts, Bruce Smith and Josh Greene, examining some of the risks associated with private placements. From investment-related risks to industry risks, management risks, and offering related risks, we offer valuable insights to help you make informed investment decisions. This article distills the key points we covered. For additional color, we encourage you to read Risk vs. Return Considerations for Alternative Investments here.
Investors should also ensure they understand the differences between private and public securities, which can be found in Investing in Private Companies vs. Publicly traded ones here. The following article focuses on some of the more prominent risks associated with direct private investments and draws upon the complementary video to be found at the end of the article.
Investment-Related Risks
Josh Greene, VP of Sales and Analytics, emphasizes the importance of understanding one’s risk tolerance and being aware of economic condition risks, such as rising interest rates which can impact various investments like real estate and equipment financing.
Bruce Smith, VP of Investor Development, highlights illiquidity as the most predominant risk factor when considering investing privately. Investors must be prepared for a “buy and hold” strategy, knowing that they cannot resell or hypothecate the security during the investment period.
Industry Risks
Josh shares insights on adverse conditions that can affect management teams and investments. Examples include structuring transactions around crop insurance policies in agriculture, should the crop suffer from a blight or cold weather, for instance. He also notes the risks endemic to products which require regulatory approvals in specific industries, such as pending FDA approvals or marijuana legalization.
Management Risks
Not all management teams are equally effective, according to Bruce. As companies grow, the demands of a larger company may require a different skillset with a different vision. In some cases, it may be necessary to replace managers to mitigate such risks.
Offering-Related Risks
Among a litany of offering-related risks, Bruce focused on missed projections. A projection is just that – a management team’s best guess as to future sales and expenses. But, as Josh notes elsewhere, no one can know all the risks, and unknown risks can extend the sales cycle, or supply chains can break down, or large customers can be wooed away. Projections and forecasts may not always align with market realities. It’s essential that investors understand that small changes in condition can affect the success of a private placement.
Conclusion
Investing in private placements comes with a unique set of risks. By realizing that some (or all) these risks — investment-related, industry, management, and offering-related risks – can occur, investors should assess whether their risk profile matches private investments, and they should decide how much they are willing to allocate to this portion of their portfolio and to each investment.
As our experts, Bruce Smith and Josh Greene have shared, working with a knowledgeable investment bank like Carofin should be able to help mitigate potential pitfalls and lead to a successful investment experience.
Watch the full episode above and if investing in direct private investments suits you, we invite you to review our current offerings here.
