Dos and Don’ts of Private Equity Investing
When moving into the realm of private equity and venture capital, it can be difficult to determine which are good investments and which are not. Even the most experienced venture capitalist such as Efraim Landa can step out on a deal that was less than perfect. Every investment comes with risk but there are some things that you can do to help reduce the risks associated with private equity funding.
Do Consider the Founder
Before investing in a business one should take a good look at its founder. The founder should have experience and expertise in their domain. You want to deal with a founder who has a real personal conviction about what they are attempting to build. They also need to have the character to stay with the idea through all the tough times that come. Determination can go a long way in bringing an idea into fruition. Having a great idea is a great place to start, but a founder must be able to execute on that great idea. They need to be able to orchestrate all the moving parts of a business and make the right allocations for the capital available to them.
Do Diversify Private Equity Investments
The primary reason that private equity funds should be diversified is to avoid concentrating risk. By holding at least 6 different funds, it can be relatively easy to achieve a proper level of diversity. There are several considerations to be made in order to achieve a diversified portfolio. Considerations include:
- Investments in different stages can help reduce some risks.
- Geographical diversification is worth considering.
- Timing has a major impact on funds and exits are impacted by many economic circumstances
- Divide the focus of investments. For instance, technology is a broad industry but it can be subdivided into sub sectors such as healthcare technology, life sciences technology, communications and information technology.
Do Ensure the Appropriate Fund Sizes
When you enter into private equity or venture capital deals you should already have several strategies in mind. Make sure your strategies are appropriate for the size of the funding. One example is tech funds which take far less to build these days than they did a few years back.
Do Think Outside the Box
It can be easy to fall into the trap of thinking every investment is going to run exactly like the last. And while it is beneficial to have a plan, don’t forget that there are times to look outside the outline and create a customized plan for a particular business. For instance, Uber is one of the top VC deals of this year. Many may have passed up this profitable investment because they don’t actually own the technology needed to run the business. Uber uses Google for instance, and cannot operate without it. Many thought this was an increased technology risk not worth taking. However, the founders of Uber are a good example of one who has the domain experience and can provide services while relying solely on the technology of another company.
Don’t Fail at Communication
Communication is an essential part of any financial transaction including private equity investments. Both the investor and the business have to be able to align their thinking toward common goals in order to move forward. They must reach an understanding of an agreed outcome and agree on what “success” looks like for the particular investment. Effective communication is very important to achieving the desired outcome from the investment.
Don’t Overleverage the Deal
One of the major pitfalls a private equity investor can find is of creating too much debt. When a company is overcome with too much debt, it can undermine the soundness of an investment. Many times a venture capitalist goes in with debt in mind and reorganization later on to reduce that debt. However, it is best to avoid saddling a business with too much debt because of the risk of not being able to reverse its effect.
Don’t Maximize your Profit at the Expense of the Investee
A private equity firm invests in a company but it is also promising support and direction along with funding. The success or failure of a business owner affects the PE investor as well. It is not beneficial for either party for the PE investor to be concerned only with getting a return. Of course, this is a primary goal, but the focus should be on making the business profitable and your ROI will be profitable as a result. Remember to focus on the business rather than your own success. By ensuring their success you will also have a successful venture.