Investing in private companies might seem exclusive, but you can typically do it indirectly via ETFs and mutual funds. However, most individual investors cannot do so directly, as there are guardrails put in place. More specifically, only institutional and accredited investors are allowed to be direct investors in non-public private companies.
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Rules and Regulations for Investing in Private Companies
Private companies are ones that don’t offer their stock to the public at large. They don’t adhere to the SEC reporting and oversight regulations that apply to publicly traded companies, and are usually owned by a small number of founders and initial investors. You won’t find a private company listed on the New York Stock Exchange because, until they go through the IPO process, they’re not allowed to sell their shares on open markets.
Instead, private companies can sell shares of stock to what are known as “accredited investors.” While the SEC publishes further details on its website, an accredited investor generally fits one of two definitions:
- Institutional Investors: Institutions, such as a bank or a university, can buy assets restricted to accredited investors.
- Sophisticated or Wealthy Investors: Individuals who have a minimum level of wealth or experience qualify as accredited investors. If you make more than $200,000 per year/$300,000 per year jointly, or if you have at least $1 million in total assets, or if you hold a qualifying financial license, you can meet the standards for accreditation.
Accredited investors can invest in private companies and other types of assets that are restricted from the public at large. This is generally because the government considers something like a private company to be higher risk.
Private firms don’t need to publish information about their finances and business operations, which makes it easier for them to mislead investors. Accredited investors are more likely to have the knowledge to properly vet a business like that, and it’s more likely that they can handle the losses of a higher-risk asset.
Ways for Retail Investors to Invest in Private Companies
The rules around private investing are straightforward. If a private company has issued shares of stock, individuals cannot buy those shares unless they qualify as an accredited investor.
However, there are a few ways that you can still look into this market:
Early Investment
Ordinary investors can’t buy shares of stock in a private company, but that doesn’t mean you can’t give someone startup capital. If you can find a private company young enough that it hasn’t yet issued shares of stock, you can invest by making a deal directly with its founders. This is the difference between buying shares of restricted stock vs. giving someone seed money to get their company off the ground.
On a very small scale, it’s not uncommon for people to pursue this option through local organizations. Many communities will have angel investor clubs that give startup capital to local entrepreneurs. This can be a fun way to get exposure to the startup scene, but you’re very unlikely to make any significant amount of money off a club or a local business. Instead, your best bet is to connect with someone who has a very strong idea for a business and is looking to get started.
But be careful, as this is a legal grey area. That’s because the point at which a company shifts from “startup loan” to “restricted asset” is not always clear. We cannot recommend doing this unless you have a pre-existing relationship with the company’s founder and a solid understanding of their potential business.
Funds
The better way to invest in private companies is to invest around them, so to speak. There are several ETFs and mutual funds that give their investors exposure to the private market. They do this in a number of ways.
For example, some invest in companies that themselves invest in private companies. Others invest in sectors that tend to track the performance of private companies (such as by investing in companies that private companies rely on or industries that have a large number of private firms).
This tends to be the best way for individuals to invest around private companies. Funds give you a diversity of assets, which helps to mitigate the risks of this market. At the same time, they have access to the kind of information that private companies may not publish to the market at large, which helps them decide where to invest.
Private Equity Firms
As noted above, many private equity and other investment firms offer shares of stock themselves. For example, you can invest in Warren Buffett’s firm Berkshire Hathaway on the New York Stock Exchange.
These companies, in turn, invest directly in private companies. As a result their value will reflect the strength of these investments.
Buying shares in a private equity firm can be a strong move. These are almost like buying a fund, because the firm’s profits reflect its portfolio overall. However, these are still individual equities. That makes them higher risk, but potentially higher reward, compared with something like an ETF or a mutual fund.
Private Companies vs. Public Companies
One of the notable advantages of private companies is their ability to focus on long-term growth without the constant scrutiny of public markets. Public firms are often criticized for being overly focused on short-term results, driven by the need to meet Wall Street’s quarterly expectations. This pressure can lead them to prioritize immediate profits over long-term value creation, potentially sacrificing opportunities for innovation and sustainable growth. For instance, a public company may be hesitant to invest in a new product that could take years to develop and yield returns, fearing the impact on short-term earnings.
Private companies, by contrast, have more flexibility to invest in long-term projects that may not pay off immediately, but have the potential for significant future gains. Without the constant pressure to meet quarterly expectations, private firms can pursue strategies that align more closely with their long-term goals, fostering innovation and creating sustainable value over time.
Direct Participation in Profits
Ownership in a private company also provides the opportunity for more direct participation in the firm’s profits. While public companies may see their earnings grow, these profits are often retained by the company unless distributed as dividends or used for stock buybacks. In contrast, private firms can distribute profits directly to their owners, offering a more immediate return on investment.
Additionally, owners of private firms, especially those with significant stakes, often have a more substantial role in the decision-making process. This level of involvement can lead to more personalized and strategic decision-making, aligning the company’s direction with the owners’ values and long-term vision.
Bottom Line
Unless you’re an accredited investor, you can’t directly buy shares of stock in a private company. However, you can invest in funds that track this part of the market and can buy shares of private equity firms that do invest in private companies. This can be a good way to get exposure to private shares, even if you can’t buy in directly.
Investment Tips
- A financial advisor can help you invest in many different types of companies. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Investing in a mutual fund or an ETF can be a very strong way to build your portfolio, but what exactly does that mean? Never fear if you’re brand new to the mutual fund game, we’re here to help.
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