The concept of multiple streams of income is one of the main pillars of wealth creation. All income streams; active income or passive income. Active income is earned through actively working and spending time and energy in order to be rewarded for your service. If you do not work, you cannot earn active income. We earn that from our salaried employment or business. Passive income on the other hand, does not require additional investment of time and energy after the initiating processes. Typical examples are dividends from company shares and interest from fixed deposits. After the initial efforts to earn the money, research the company and buy its shares, the shareholder does not need to do any additional work to continuously earn dividends and bonus shares from the company. Some investments straddle active and passive incomes. A good example is rent from landed property. A landlord is able to passively earn money from her property continuously; however, a wise landlord would actively spend time and money inspecting the property and making necessary repairs that would safeguard her investment. Since these inspections and repairs are infrequent, rent can still be classified as passive income.
Another hybrid investment is private equity.Many people need additional income to make ends meet but because of current commitments to our employer or business, we are not able to give the required time and attention to another “job”. Existing alongside with us, in our communities, are many small business owners who are highly skilled in what they do and are running their businesses profitably. These business owners need additional capital to buy equipment or stock that would move their businesses to the next level, grow the national GDP and reduce unemployment. But many small business owners do not have access to bank loans or where microloans are available, the interest rates are too high. This creates a viable supply and demand situation that people seeking additional income can explore through private equity. It creates passive income because you will not be involved in the day to day running of the business, but you must actively monitor your investment (much closer than a stock market company), hence the income is also an active income – hybrid.
Gone are the days when business owners had a mother hen mentality in protecting their company’s ownership. The need to scale up and harvest the full potentials of a business far outstrip all parochial inclinations. How then do we invest in private equity? Here are some guidelines. Invest in a business that you understand its production and income cycles. Ensure the current owners are people of same moral standards, who share your own business values. They must not have personal financial obligations that can impair the business’ assets.Ensure they have a business plan that demonstrates verifiable and realistic revenue sources and profits. If the business has existing debt, understand how it is collaterised and how repayment is being done. If necessary, get professional advice to breakdown the figures for you. Get an independent valuer to value the business so you can determine what percentage of the business your money should be acquiring. Do your due diligence with the company’s suppliers, customers, regulators, bankers and neighbours.Ensure the original owners (who work there 9-5) retain at least 49% ownership;so they can continue to give their best. Sign a legal agreement that outlines your financial rights andyour rights to inspect company records, influence policies and effect changes that would protect your investment. For instance, your signature should be required for any bank loan, major acquisition or sale. The agreement must also include a feasible exit strategy for you. Register the legal agreement with the Corporate Affairs Commission. Retain your own legal adviser; do not share one with the business owner, his loyalty may be questionable .Investment in a small business requires close supervision; so review sales records and bank statements monthly, attend management strategy meetings monthly, be a bank signatory for large transactions, etc. Investing in startups is very different from investing in an existing profitable business. In additional to meeting the conditions spelt out above, invest only in startups belonging to close friends and family and invest only what you can afford to lose.
Private equity investments benefit investors, businesses and the economy at large. It is a veritable source of additional income. Let’s explore it.