How to Invest in Private Companies - SmartAsset

An individual investor you can invest in private companies, but only through side options like an ETF or a mutual fund. An individual investor cannot invest in private companies directly because they are restricted to accredited and institutional investors. If you want help inveting in public or private companies, consider working with a professional financial advisor.

Rules for Investing in Private Companies

Private companies are ones which do not offer their stock to the public at large. They do not 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 Individuals – 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 cannot 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 has not 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. This is a legal grey area 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 exchange traded funds (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 (for example, 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

Finally, as noted above, many private equity and other investment firms offer shares of stock themselves. For example, you can invest in Warren Buffet’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.

The 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

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.
A financial advisor can help you invest will 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.