What considerations should you take into account before investing in a private equity company?

Answer 1

You should ask to see audited versions of the income statement, balance sheet, and cash-flow statement. You should see a list of revenues by customer (to make sure no customer accounts for no ore than 5-10% of total revenues). Understand how they make money: what do they sell, who do they sell to, how do they sell it. what are their gross margins? Are there any production, delivery, support or warranty risks? Ask to interview two or three of their largest customers. Find out why they bought the product(s), if they like them, and if they will continue to buy them in the future. Look at their accounts receivables and see what the average time outstanding is for invoices. Be very skeptical if receivable account for more than 3 months of current revenues. Look at their accounts payables and see if they are a) in arrears on any big-ticket iterms, or b) have any large payments (e.g. balloon payments on leases) coming up in the next 24-36 months. Get an understanding of the competitive market. Who else sells into this market? Does the company you want to invest in have a defensible competitive position through technology, market presence, people, something else? Find out if any key employees have left in the last 6 months. Contact them and find out why they left. If possible, interview the current key employees to gauge their understanding of the business and their commitment to stay with the company. Make absolutely sure there is no outstanding litigation against the company. Get a good securities lawyer to draw up the terms under which you will invest. Most importantly: don't invest on a hunch! Do your homework, understand their business model, and run away from any company that won't willingly provide you with the data items listed above. When all else fails, invest in a mutual fund or money market. The upside may be lower, but so will the downside. Or if you're really smart, invest in your own company!