Author Topic: Illiquid Investments for somebody starting out  (Read 3649 times)

tbcg12

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Illiquid Investments for somebody starting out
« on: August 30, 2014, 02:54:28 PM »
Question for those investment experts out there

I have the ability to invest in a privately held company that is available for a discount of between 20% and 30% estimated value. The company has been around for almost 9 years and due to the recession, has not led to large capital gains for the initial investors. That being said, the company is extremely well capitalized and should be able to weather any economic storms because of it.

Now to the question: Since many initial investors are of retirement age and need cash flow, the stock is available at a discount. At 21 years of age, with a high savings rate, and good starting income (with zero debt) should I sink a large chunk of savings into buying these shares with the understanding that much of the payoff will likely be when the company is sold in the next 5-10 years? Due to my age I am thinking I should go for it since I will not need the liquidity in the next few years and I can hopefully "lock" in some immediate equity. Am I missing something here?

Thanks in advance.

thedayisbrave

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Re: Illiquid Investments for somebody starting out
« Reply #1 on: August 30, 2014, 04:09:09 PM »
I'm not sure we really have enough information... Have you done your due diligence? Have you seen firsthand the accounting statements that the company is well capitalized? "Should be able to weather any economic storms" is not really an adequate basis for investment, IMHO...

But, at 21 you can potentially afford to take some risk.  That's not an endorsement.  Do you know enough about finance to be adequately valuing the company and the stock? (Disclosure: I'm 24 and I know I'm not even close to knowing how to adequately value a company).  Is this money you can afford to lose, i.e. if the company went belly up tomorrow and you lost ALL of your investment, would you be OK with that?

Just some things to think about, hopefully others will chime in. 

RichMoose

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Re: Illiquid Investments for somebody starting out
« Reply #2 on: August 30, 2014, 04:56:19 PM »
I would be very cautious of this. It's extremely hard to properly value private companies, especially if they are relatively small. Here are my questions:
  • Do you value based on income (p/e ratio), assets (p/b), sales, replacement costs, how much for goodwill?
  • Does the success of the company depend on just one or two key people that may leave?
  • What kind of competition is there in the market?
  • If the company generates significant revenue, why are investors really selling?
  • If you buy will you be receiving yearly income in the form of dividends that are a good rate of return, or are you just banking on appreciation of your capital?
  • How difficult will it be for you to sell?
  • Does the company depend on the well-being of a very local economy?

If you're still eager after critically answering all these questions, then go ahead... you can afford the risk at your age. That being said, I would say DON'T DO IT!! and stick with boring index funds. (I'm 25).

johnny847

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Re: Illiquid Investments for somebody starting out
« Reply #3 on: August 30, 2014, 05:34:03 PM »
In line with the others... I would never recommend that no more than about 5% of your portfolio be invested in any individual stocks. Because it is incredibly difficult to consistently beat the market year after year, I would just stick with boring index funds.

If you really want to take risk, go with 100% indexed stock, such as VTSAX. But I wouldn't recommend any individual stocks.

oldladystache

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Re: Illiquid Investments for somebody starting out
« Reply #4 on: August 30, 2014, 06:02:37 PM »
Quote
Now to the question: Since many initial investors are of retirement age and need cash flow, the stock is available at a discount.

I don't believe you can get the stock at a discount from its true value. If it was really worth more they would sell it for more. 

hodedofome

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Re: Illiquid Investments for somebody starting out
« Reply #5 on: September 01, 2014, 08:57:46 AM »
Quote
Now to the question: Since many initial investors are of retirement age and need cash flow, the stock is available at a discount.

I don't believe you can get the stock at a discount from its true value. If it was really worth more they would sell it for more.
Your finance professor may have spewed that Crap out of his mouth but that's because he lives in his fantasy world and not in the real world. Prices get out of line all the time and nothing is 100 percent efficient all the time.

That being said, the title of the thread should answer your question: newbie wants to invest in illiquid_________.  No No No. Nobody should invest in illiquid anything (besides your house) until you have enough $$$ and you can afford to lose your entire investment. And even then, all private investments wouldn't be more than 5-20 percent of your million+ you have stashed away.

NorCal

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Re: Illiquid Investments for somebody starting out
« Reply #6 on: September 01, 2014, 11:03:06 AM »
Only touch illiquid private companies if you actually have the information to put a value on the company (including full AUDITED financial statements and capitalization tables) and you have the professional experience to put a real valuation on the company.

I know a few people with the ability to do this, but I haven't met anyone at the age of 21 with these skills.  The people I know that can properly value a company all have Master's degree's and years of work experience.

Equally importantly is the terms and conditions of investing in a private company.  Buying private shares is nothing like buying public shares.  The company will most likely restrict your ability to sell your shares at a later date.  What are those restrictions?  How much can/will the company dilute your existing shares by selling more to new investors?  Do the existing shareholders have preferential voting rights or economic rights to the shares you're buying?


tbcg12

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Re: Illiquid Investments for somebody starting out
« Reply #7 on: September 17, 2014, 07:40:11 PM »
Thank you for all of the replies. Many of the concerns you have all raised are the same ones I have been thinking about.

As far as the financial statements and ratios, yes I have seen the audited financial statements and they are in great shape relative to their industry. The estimated value I referenced is an average of two third party valuations that are done on a quarterly basis. Knowing the management of the company (immediate family) I do believe that they are completed by truly independent companies.

Norcal: Great point about the restrictions of the shares. I have taken a couple classes on structuring terms for private equity and having read through this particular situation there is nothing too exotic. As far as selling and buying shares they can be sold using the company as an intermediary or directly to a buyer/from a seller.

The part I was most worried about and should have asked for specific advice on relates to what Oldladystache posted:

ASSUMING that the third party valuations are somewhat realistic (yes, a big assumption) and I can get it at an approx. 30% discount from this price, is it simply reward in-line with the liquidity risk I am taking on or is there some room to make equity upon acquisition of the shares by buying below market value? Do any of you experts have advice on figuring out how to value that liqiuidity risk?

As far as personal experience, I have a CPA and am working on the first step of the CFA...but as discussed several times on these forums do NOT make somebody with these certifications an expert, hence the initial question.

Thanks again!

 

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