IN view of the low interest rate regime and the current negative growth in the stock market, it is necessary to explore alternative investment options. Investing in profitable businesses managed by competent people is one of the most profitable ways of investing and generating additional streams of income. Its return on investment outstrips returns from money or stock market assets. There are established private equity firms that invest heavily in large startups and we can replicate that business model on a smaller scale. Opportunities abound to invest directly in growing businesses in our communities or indirectly through crowd funding platforms or through peer-to-peer lending. Even though the latter was given a bad name by the infamous MMM pyramid scheme.
Private equity investment involves identifying profitable businesses, buying shares in them and so becoming a part-owner, just like it is with stock exchange traded companies. This way the business gets interest-free money for expansion and you get an additional source of passive income (income earned with minimum work). Many businesses are in dire need of funding, bank loans are too expensive. If more of us could invest in private equity, our communities would flourish through increased employment, higher productivity and prosperity.
Like with all investments, you must conduct a due diligence exercise before parting with money. I recommend using the appraisal methods that banks use – the 5 Cs; character, capital, capacity, condition and collateral. Thereafter, ensure that your investment (terms, conditions, responsibilities, privileges etc.) is properly documented and registered appropriately with the Corporate Affairs Commission and a Notary Public.
The first of the 5 Cs is character. You must ensure that the current owner-manager of the business is a person of impeccable character with similar ethical standards as yours. Good corporate governance structures are in place and the manager must have earned your trust; so you can have peace of mind and avoid unnecessary suspicions. Capital is the second consideration. How much money has the owner invested already? If she is not more financially committed than you then she may not be diligent in managing the business. Financial investment is an indication of commitment. Next comes capacity. Is the owner-manager technically competent to manage the business? Has she demonstrated the soft skills required to manage staff and customers? How about the entrepreneurial skills to manage supply chain, business risks etc.? Zeal and sincerity cannot replace competence. Condition is another factor to appraise. This includes location, staff, structures, internal control etc. Is the area prone to insecurity or flooding? Is there sufficient internal control in place or is stealing rampant? How about staff discipline? How accurate, up-to-date and safe are the company records? The fifth C is collateral. Since you are becoming a part owner, you cannot ask for collateral, but you can ask for a place on the Board and a say in the decision making on vital issues like accessing bank loans.
However, you could limit your investment to a project without buying into the company itself e.g.part-finance a contract and share the profit on the contract only.
A private equity investor not involved in the running of the business must monitor her investment is by reviewing the company records frequently. Ensure a good recording system is in place, preferably cloud based, that records production, sales and financial transactions. Review it diligently and give relevant feedback that demonstrates you have done a detailed study of the records.
Crowdfunding like the name implies, involves a large group of people pooling money together to fund a project. The crowd funding platform stands as an intermediary between the business owner and the investors. It is like buying shares in the proposed project –not the company behind it. When we invest through crowd funding platforms, they should have done all the due diligence required on these projects and we should feel safe to invest in the projects they recommend. However, it is important to conduct due diligence on the crowd funding platform itself before we can trust its recommendations.
Peer-to-peer lending is the miniaturized version of crowd funding. The funds for investments are obtained from one person to fund a proposed business. Here again, there is a platform that introduces and manages the investments. We must learn from the bitter experience of the past and ensure we conduct a thorough due diligence exercise on the platform itself. We must avoid and investments that promise unrealistically high returns. Higher returns imply there is a higher risk of losing the money invested.
Investing in private businesses builds our society and creates high-yielding investments for us. So, no more parking our funds in low income money market instruments. Let’s invest in our communities. Happy investing.