The Tycoon Report

Answer these three compelling questions before considering an investment in a private company. By Richard S. Grome

It is all about risk and reward. Understand the amount of risk you are taking relative to the reward that you might receive. I consult for small medical equipment companies. Often, I am engaged by companies to find investors. This usually means seeking out private investors for a small under capitalized company. These investments can be profitable; but, are not for the “faint of heart”. They are not appropriate for the small investor or the emotional investor.

For the investor, this type of an investment is an illiquid, long-term investment with on going, and sometimes changing risks. The typical company looking for such an investor will usually take significant time to show a positive cash flow, and cash flow is the most important financial aspect from both the company’s and the investors viewpoint. Cash flow should eventually translate into profits and subsequent returns to the investor’s stake in the company.

Three key questions to be answered before consideration for investing in any private company are:

1) Does the management of the company have a reputation for integrity? You are investing in the employees of the company, and the integrity of the company’s culture is the most important attribute to look for before seriously considering any investment. Take particular notice of the entire executive team. The background and experience of these managers is an important predictor for the company’s future success. Expect the managers to have the highest integrity with experience in both the industry and in business management before considering any investment, or for that matter before considering any additional questions. I can tell you from experience if the answer to this question is unsatisfactory, look for another investment. It is irrelevant how good or unique the product or service to be provided appears; in the long run, the viability of the company is questionable.

2) Has management developed a business plan? A good idea or a good product is not enough. This is often a problem, especially with inventors. I have had inventors that really believe that if they build a “better mouse trap” people will beat a path to their door. They won’t! Management must have a well thought through, solid business plan with solid financial projections reflective of how the business will operate. Has management been realistic in projecting the amount of capital required to make this company successful? If you are uncomfortable in judging this yourself, get expert help from someone who knows this industry. Under capitalization has been the down fall of many, many companies.

3) Do you understand why the company will be a success? If you do not understand the product, service, or industry, your risk increases. Getting sucked in by the hype puts the preservation of your capital at extreme risk. If you can not be objective, stop. If you can not summarize why this company will be successful in a couple simple sentences, stop. Keep in mind, if you are the only one, or one of a few, buying a piece of this company with no oversight by the Securities and Exchange Commission (SEC) you are on your own to determine the accuracy of the company’s representations.

Be satisfied with the answers to the above three questions before moving forward on the potential investment or further consideration is a waste of time.

If you are satisfied with the answers then it is time to dig deeper into the strengths, weaknesses, opportunities and threats (SWOT) of the company and the industry. This “SWOT” analysis will take time and energy. If you do not feel qualified to perform the analysis, hire an expert consultant for help. The cost for due diligence is far less expensive than losing your entire investment.

Richard S. Grome is the past president of a medical equipment company and the past president of a captured venture capital arm of a medical equipment company. Richard now has his own consulting company, Heritage Group, LLC, in the areas of company management, strategic planning, sales and marketing, and finance for medical equipment companies. Richard can be reached at 770-642-6307.