Trade settlement on the New York Stock Exchange (NYSE) or Nasdaq refers to the length of time a seller has to deliver his stock to the buyer and the length of time the buyer can take to pay for the shares. The current settlement rule is referred to as “T+3” settlement, which means that the stock trade must settle within three business days after the stock trade was executed. For example, if you sell the stock on Tuesday, the money should be in your account by Friday.
However, investments in private companies, or private investments, do not have the same advantages as those of publicly traded companies when it comes to liquidating or selling these investments. They can often take months, if not years, as they are not registered for such sales and do not have the access to the capital markets.
Why is this important? Simply because when an investor or potential investor considers investment opportunities in private investments versus publicly traded shares, it is important to identify the advantages and disadvantages of these two types of investments -- their access or ability to trade on major exchanges, the ability to liquidate positions in a matter of days -- because it can make a huge difference to pool of potential investors.
These differences to consider when making an investment in privately held companies include:
Access to even secondary markets – unlike publicly traded shares, private investments not only do not have access to the primary exchanges, they do not have access to even secondary exchanges, which can often relieve some investors’ concerns of realizing their investments. Without these markets, they can often deter potential investors from buying positions in such companies.
Prospects of a possible sale or public offering – Most publicly traded companies are often followed by major investment banks and financial markets, scrutinized and therefore have visibility in the market for possible divestitures, mergers and acquisitions. Where private companies are large and successful, there are likely buyers in both the public and private arena with the available capital, who would happily acquire such companies to improve their portfolio holdings for financial or even synergistic reasons. However, many private companies – large and small – aren’t on the radar of many of the major financial institutions; they do not have the necessary profile that would enable a market of potential investors to be created or interested in such an investment, and therefore can affect the salability of the investment.
Transferability of Interest – In many instances, privately held entities have significant restrictions on the sale of interests. These restrictions often can lead to the length of time an investors is even allowed to put their investment up for sale or possibly converting the equity rights to simple assignments, thereby impacting the value of the investment itself.
Sales and Redemption Policy - Potential investors of private companies often look for controlling interests; simply for their ability to control the company assets, their cash flows quality and their timing of distribution. However, potential investors interested in investments of minority interests in private companies should concern themselves with inability to do all of the above. Therefore, potential investors should consider the company’s sales and redemption policies, its history of consenting to exits, transfers, or withdrawals where there is little or no penalty.
Distribution Policy and Paying Capacity – where private investments are concerned, investors and potential investors of minority interests should concern themselves with the distribution policies when assessing their worth. Regular distributions from these investments will often attenuate the risk of investing in the company.
Corporate information and disclosure requirements – For all publicly traded companies, investors are provided with detailed disclosure of quarterly and annual corporate and financial information that is regularly audited by third party auditors. However, investments in private companies should often be concerned with the level of information, which is often limited and unaudited.
All of the abovementioned factors should give pause to those interested in buying a minority stake in a privately held entity, and should consider the impact of the above mentioned factors on the purchase and future sale of such investment. Appraisers often consider these factors when arriving at the value of any privately held interest, because the risks associated with investing in a privately held company is clearly different from the risk of owning share in a publicly traded company.
Appraisers have long considered these impacts and considered various researched studies that date as far back as 1966 through the present to gain a better understanding of their impact. These factors and studies suggest that the difference between investments in privately held companies when compared to publicly traded companies can be as little as nothing to as much as 40% or even higher.
INVESTMENT CONSIDERATION WHEN INVESTING IN PRIVATE COMPANIES
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