The Tycoon Report

4 Questions to Ask Before You Buy a Private Company

I HAVE TO ADMIT - YOU ALL REALLY IMPRESSED THE HECK OUT OF ME THIS WEEK.

In last week’s Tycoon Report article, I mentioned I was starting a new series about how to invest in private companies.

I also mentioned that in today's article I'd share with you the 3 main questions I ask before investing in any private company (or any public company for that matter), and I invited you to submit your top three questions as well.

Boy did you come through! In the past week alone we've received almost a hundred full and detailed responses from many of you, offering us your top 3 investing questions. And before I go forward, I wanted to thank you for making your contribution to the cause. The questions you submitted were thoughtful, relevant, and valuable.

Not only have you helped me better understand where I could have the biggest impact in helping you gain assassin-like precision in your investment operations, but your feedback has helped me plan exactly how to teach this subject.

Planning how to teach this topic has been one of the biggest challenges I've had. Remember, I've debated running this series for over a year already, and the topic is so big - and the subject matter so important - that I haven't wanted to screw it up.

I'm not overstating the case when I say I have so much knowledge to share with you, I want to do it in the best way possible. So here's what I came up with.

By the end of this series you will know how to analyze, value, and negotiate any private business opportunity you're presented with as an investor.

But investors aren't the only ones who will gain from this series. Entrepreneurs, those incredible engines of our economic growth, will be able to apply these lessons as well. Remember, the principles you use to judge whether to invest in a business are the same ones you would use if you were starting or running your own business.

My main point in discussing all of this is to say that, based upon your incredible feedback this week, the scope of this endeavor has widened immensely.

The good news is that I'm up to the challenge. And I know that if we work together, as a team, that we'll all be better off for having done it.

OK. Are you ready? Let’s dive in.

After reading your feedback, I've decided that the best way to get the most amount of information to you in the clearest manner is to break this big lesson into pieces.

Here's what I intend to do: This week I plan to fulfill the promise I made last week, and share with you the 3 most important questions you should ask before buying a piece of a private company.

Since I wanted to add to the scope of this lesson, I've decided to break out an additional question and share the 4 main questions I use when judging an investment opportunity. That's right - I'm going to share with you my full arsenal, no holds barred.

So here are the four questions, and here is how we plan to address each of them in the coming weeks:

1. Do I understand the business?

This is the first question you have to ask yourself before you invest in anything. But when I say "understand the business", I don't mean a superficial understanding of the business. Everybody knows that Joe's Pizza Parlor makes pizza pies.

To really "understand the business" you must know exactly how the business makes its money and exactly where the business spends its money. That's the only way you'll ever be able to properly analyze the company's Profit and Loss statement.

Last, but not least, you have to know exactly how the business markets itself. One of the most common mistakes I see new entrepreneurs make is that they don't have a real marketing plan. Sure, many young businesspeople pitching you their ideas will have what looks like a great marketing plan.

However, unless they can tell you exactly what their lead acquisition and customer acquisition costs are it is not a true marketing plan. Period. Many businesspeople will tell you that it's impossible for them to provide that information to you.  That's BS. Anybody who can't provide you with that information hasn't thought about marketing their product or service hard enough, PERIOD.

In the coming weeks, we'll spend time in this section so you understand how to determine if the person bringing you the idea understands the business they're asking you to invest in. You'll have so many questions you'll be able to ask that if they can't answer them, you don't invest. It's that simple.

2. Am I comfortable with management?

Many of you wrote about trust in management as one of the key questions you should look at. You were spot on with that assertion. But how can you tell if the person pitching you the idea is trustworthy? That's an art in and of itself, and we'll dive deeper into that in coming weeks also.

One thing is certain: 97% of the investment opportunities I see are shot down before I even get to this phase of the analysis. Indeed, if I find a business owner who can withstand my withering barrage of questions from the "understand the business" section of my analysis, they've already gone far in earning my trust.

Of course, they have further to go - and there are things we can do to help screen them further – but unfortunately, having good conversations with intelligent, reasonable and humble entrepreneurs are rare.

3. What is the business worth?

Let us assume that we understand the business and we trust the person pitching us the idea. Now, we have to determine what the business is worth.

Many of the companies you'll be asked to invest in are start-ups (very high risk). Some of the companies you may seek investment opportunities in may be existing businesses (like Joe's Pizza Parlor). Either way, you want to make sure that once you get to this part of the negotiation you'll have a good handle on what the business is worth.

(PS--You could never determine the worth of a business if you didn't first "understand the business".)

4. What do I have to pay?

Having a wonderful company to invest in is one thing. Getting it for a good price is entirely different (try convincing a dealer to sell you the latest Mercedes 500SL convertible for $10,000).

Hence, the sole objective here is to quantify the difference between value and price (what something is worth versus what you have to pay for it).

Many people will argue that they invested in XYZ Company because, in their words, it was a "good company".  But to invest at the highest level of the game, you have to be able to differentiate between a good company and a good price.

There are many great companies out there for you to invest in, but the more you pay to invest in them the lower your return will be.

Joe's Pizza Parlor might be a great concept in a great neighborhood with a great marketing plan and great management. But if the price isn't right, you have to be disciplined and walk away.

Remember, the $100,000 that Joe is asking you to invest in his company could be invested into AAA Corporate Bonds with a 6% yield. That means you could earn $6,000 on your $100,000 investment without doing a single bit of hard work.

In the case of Joe's Pizza Parlor, or any other start-up you're looking at, you want to make sure that the money you're investing will get you much more money then you could get on your own investing in bonds. And if the price isn't right, that isn't going to happen.

Next week, I'm going to go into greater depth explaining the questions you must ask the entrepreneur to truly understand the business in which you are being asked to invest.

If any of you would like to offer a sample company as an example of the business idea, I'd be more than happy to use it next week.

Until then,

Dylan Jovine
Self-Described InterGalactic Cheap Stock Business & Investing Guru