Private vs. Public Investments - one man's view

Part Two
By Harlington L. Hanna Jr.

Due Diligence Requirements

All investments private or public should be thoroughly investigated. Private placements inherently present much more of a problem to the investment analyst or researcher. The requirements for proper due diligence into an investment opportunity are somewhat complicated. The typical unsophisticated first time private investor usually does not have the resources or capability to adequately perform this task, and probably should pay a professional advisor to undertake the task. In any event proper due diligence of private companies and offerings requires significant resources which in effect must be added to the bottom line of the investment. Public companies and offerings by contrast are much easier to evaluate due to the numerous reporting and operational activities and news required by the exchanges and the S.E.C. Even so research and due diligence into public companies and offerings is a formidable task often requiring professional advice. The due diligence necessary to effectively evaluate the distant private company and offering is however an almost impossible task for the typical unsophisticated investor.

Corporate Control

Perhaps the greatest benefit to a private investment is the ability to exert more control over the operations of the business. This control can be extremely important I influencing things like dividend declarations, debt control and company direction. Obviously improperly exerted control by incompetent shareholders can also be detrimental to the professional management of the company. Also control is not always available in private investment deals, particularly sophisticated offerings by professionally prepared investment programs. A private investor should however seek some aspect of control if it can be arranged. Control provides a measure of safety and productivity that cannot be overlooked by the competent investor particularly considering the many disadvantages of private as compared to public investment. Public investments almost never allow for any significant amount of corporate control unless the investor has a significant holding of stock in the company. Since publicly traded companies tend to be larger with much more shares outstanding and more widely held, it is usually difficult for any one investor to acquire a controlling interest in such companies. A major advantage in a closely held private company is the ability of the investor to influence the direction of the company. This influence must however be judiciously exercised or it can become a disadvantage where incompetent controlling shareholders adversely affect the companies operations. This one reason it is important for a private investor to know who the other private investors are and to which extent they may be influential in the companies operations. Public investors in widely held companies must generally rely on the competencies of professional management and boards of directors to control the corporation. The competitive nature of most public companies in there acquisition of management talent usually affords some level of market controlled management competencies in such companies.

Important Questions for the Private Investor:

Questions the private investor must ask:

1. If the opportunity is so good then why is the private company not able to find financing elsewhere through banks, venture capitalists etc.
2. If the opportunity is so good why doesn't the private company go public, since it should be able to raise more funds in a public offering.
3. Is the private company inherently so weak that it must find funds through a private offering, and what other type of capitalization and/or financing does it have or expect to get.
4. Is the company an ongoing operating company and what is its track record?
5. Is it a start up company and most of its prospectus talks about prospective operations and income?
6. What competition does this company or project face in the marketplace?
7. Who are the other shareholders and what percentage of shares do they control.
8. What are the financial and other fundamentals of its ownership and operation?
9. What is the management, experience, and track record of its management.
10. What intellectual properties does the company hold and what is the value of these properties.
11. What aspects of the private offering do not seem to be usual and customary?
12. What are the specific terms of the shareholders agreement as to voting, transferability of shares and ownership of shares
13. What opportunities are there to negotiate a better deal or price for the shares?
14. What jurisdiction is the Company incorporated in and what state laws apply to shareholders rights.
15. Are there any special rights by law or agreement protecting or affecting minority shareholders rights?
16. Is it common stock or preferred stock being offered and under what conditions or restrictions.
17. Is it an equity (stock) or bond (loan) type of investment?
18. How much of a problem is in structuring or restructuring the private offering and what opportunities are there to structure a special offering for the particular investor.
19. What kind of control or corporate management positions are available to the investor
20. How and when am I going to receive the returns on my investment
21. What type of guarantees are there for a return on the investment
22. How are the returns on the investment to be calculated, measured, or determined.
23. Are dividends to be declared and paid or is the investment to be recouped through growth in the value of the stock.

The goal of most businesses desiring extensive growth and attainment of the advantages of economies of scale in the modern economy is to acquire such status through participating in the public markets. This natural predisposition for the most successful companies to become public provides perhaps the ultimate reason for the private investor to always think about the numerous advantageous to placing his resources in the public sector. Private investment is truly a game for the most skilled investors. Those who understand all of the facts, who can do the best research and those prepared and capable of taking the most risk. They must know the company and its promoters extremely well and they must endeavor to acquire some type of control or management position as a basis for their investment. A good starting point is to review the details of investment requirements used by major venture capital firms. Private investment is really in their domain, and unless you have a personal venture or are simply willing to take the risk of helping a family member or extremely good and trusted friend to start or continue to operate their business, it behooves you to put your money and efforts into trading and investing in the public securities markets.

Finally remember this rule…..the most flexible, most profitable deal will usually be a properly executed private acquisition, but the easier more dependable and predictable acquisition will be a public securities market transaction.

   Part One

 

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http://www.hannaian.com/distribr.htm