Buying Shares in a Private Company: 10 Things to Consider Before Investing

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Is buying shares in a private company a good investment? 

There's something exciting about being invited to become a business owner, particularly when it's a company you already know and believe in.

But Erin Skye Kelly, bestselling author of Get the Hell Out of Debt and Naked Money Meetings, wants investors to slow down and look beyond the opportunity itself.

A successful, busy business doesn't automatically mean a profitable business. And even if the company is profitable, that doesn't necessarily mean the proposed share price is fair.

The first step? Treat this like a serious investment decision, not an exciting employee perk.

How do you know what a company is worth? 

Let's say someone offers you 2% of a company for $250,000. Is that a bargain?

You can't answer that without knowing the company's actual valuation.

Erin explains that you need to look at the company's financial performance, including:

• Annual revenue and actual net profit.

• Operating expenses and cash flow.

• Outstanding corporate debt.

• The company's overall valuation.

• Whether profits are sustainable.

There's a big difference between a business bringing in millions in revenue and one actually keeping millions in profit.

And if the company is carrying significant debt, that changes the investment picture considerably.

What should you know about shareholder rights? 

Owning a percentage of a business sounds straightforward until you start asking what that ownership actually gives you.

Are the shares voting or non-voting? Are they common or preferred shares? Do you receive a portion of company profits?

Erin emphasizes that potential investors need to understand exactly what they're purchasing.

Other important questions include:

• Who makes major business decisions?

• Are shareholders entitled to profit distributions?

• Can your ownership percentage be diluted?

• What protections do minority shareholders have?

• Is there a shareholder agreement?

A small ownership percentage doesn't necessarily give you much influence over how a company operates. You need to know what rights come with your investment.

What are the biggest risks of buying into a business? 

One risk that deserves particular attention is concentration risk.

If your household income already depends on one company because your spouse works there, investing a substantial amount of your savings in that same company creates another layer of financial dependence.

What happens if the business struggles?

Erin also raises an important question: Why is the company offering employees the opportunity to buy in?

Perhaps it's a retirement or succession strategy. Perhaps it's funding expansion. But if the company needs the money to cover operating expenses or make payroll, that's a very different situation.

Understanding why the company is raising capital is an essential part of evaluating the opportunity.

What happens if you want to sell your shares? 

Private company investments can be difficult to turn back into cash.

Unlike publicly traded stocks, you generally can't simply open an investment account and sell your shares whenever you want.

Before investing, find out:

• Can you sell your shares to an outside buyer?

• Does the company have a buyback agreement?

• How is the value of your shares determined?

• What happens if your spouse leaves or is terminated from the company?

• Is there a planned business sale or exit strategy?

You don't want to discover the rules for getting your money out after you've already invested $250,000.

Should you invest in one company or diversify? 

Here's another question worth asking: What else could you do with $250,000?

Erin encourages investors to consider the alternatives, including diversified ETFs, bonds, real estate investments, and other investment opportunities.

The goal isn't necessarily to avoid private company investments. They can be worthwhile.

It's about comparing the potential return against the risks and understanding how much of your overall wealth you're putting on the line.

And before signing anything or transferring a dollar, Erin's recommendation is clear: Get an experienced accountant involved and have the company properly evaluated.

Sometimes an opportunity really is an opportunity. Sometimes it just looks like one.

Key Takeaways

• A busy business isn't necessarily a profitable business.

• Understand the company's true valuation before agreeing to a share price.

• Find out exactly what type of shares you're purchasing and what rights they provide.

• Investigate corporate debt and why the company is raising money.

• Understand how profits are distributed and whether your shares can be diluted.

• Establish how and when you can sell your shares.

• Consider the financial risks of having both your employment income and investments tied to the same company.

• Compare the opportunity with other ways you could invest your money.

• Get professional accounting and legal advice before committing.

Is buying into a company a brilliant wealth-building opportunity or a financial risk you haven't fully considered?

Erin and Keri dig into this listener's question and explore what you need to know before becoming a minority shareholder in a private business.

Listen to the full Naked Money Meetings episode for the complete conversation, more questions to ask, and Erin's perspective on making smarter investment decisions.

Listen on Apple: https://podcasts.apple.com/ca/podcast/before-you-get-in-bed-with-the-business/id1462338073?i=1000792330773

Resource Links

• Erin Skye Kelly’s Book: Get the Hell Out of Debt
• Erin Skye Kelly’s Book: Naked Money Meetings  

Explore more from Naked Money Meetings:

• Related Episode: How to Make Smarter Investment Decisions

• Related Episode: Building Wealth While Paying Down Debt

• Related Episode: Financial Decisions Every Couple Should Make Together

Additional resources:

• BDC: How to Conduct Due Diligence When Buying a Business

• Government of Canada: Share Structure and Shareholders

• BDC: What Are the Steps to Buying a Business?

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