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Part
Two
By Harlington L. Hanna
Jr.
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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