According to recent estimates, around 12.4 million U.S. households qualify as accredited investors and are eligible to participate in private investments. Of that 12.4 million, only a small subset actively invests in private companies and real estate ventures.
Why is that? In part, it’s because private investing is similar to many other financial activities (like saving, stock trading, and planning for retirement) in that it’s easiest to do when you already have the knowledge and tools to do it.
Newcomers may view the private market as a place for insiders only, especially if they lack one of the most essential elements of private investing: deal flow. Simply put, “deal flow” is the pool of opportunities from which a private investor has to choose. Successful investing in the private market requires picking winners from the pool offerings available to you. The more quality opportunities you have to choose from, the more likely you will be to pick a winner. One has multiple options for finding that stream, but some avenues may be more limited to you than others.
Personal referrals are the traditional avenue for accessing investment opportunities in private companies and real estate projects. In fact, prior to the lifting of the General Solicitation ban in September 2013, an investor was required to have a “pre-existing, substantive relationship” with any entity raising capital in which he wished to invest. That meant personal introductions were the only thing making private investments possible. (In real estate investing, this approach is sometimes referred to as the “country club” model.)
If you (or your colleagues) are well-connected to the entrepreneurial community or real estate market in your region, you may be able to generate a deal flow from personal referrals. If you know or work closely with lawyers, accountants, wealth managers, or other financial professionals whom you trust, let them know you are interested in learning about potential investment opportunities.
But be aware that relying on referrals alone will limit your options; you can only know so many people. Unless you live in a large city (and have a large amount of assets to invest), it will also be difficult for you to establish a reputation as an investor and grow your pool of opportunities. If you live in a small community or do not have a well-connected network, personal referrals may not be an option at all.
If your personal network is too limited to be leveraged for deal flow, you need to expand it. Partnering with groups of people who are experienced in private investing is a smart way to do that. There are both formal and informal networks of VCs and angel investors you can get involved with to expand your investment horizons.
Affinity organizations focused on investing or entrepreneurship can be your informal entry to the private market. Local venture capital associations, community development councils and business groups are often loosely affiliated with private investing, since their missions involve helping business owners fund and grow their companies). Such affinity organizations often host low-cost events that are open to the general public; attending can be a valuable way to bring experienced private investors into your personal network for deal referrals.
More formally, you can join an “angel group,” which is a membership organization explicitly focused on evaluating and investing in private ventures. The Angel Capital Association has more than 400 registered angel groups in its database, and there are even more globally. These groups provide members with education sessions, mentoring opportunities and a steady deal flow—typically of in-person pitches from local entrepreneurs. The Angel Capital Association is a valuable resource for tracking down the angel groups in your community.
The drawback is that angel groups typically focus on funding startup or other early-stage ventures, thereby excluding investment opportunities in real estate projects or later-stage companies and limiting the diversification range and risk profile of your deal flow. Some angel groups also require members to invest $25,000 to $100,000 per year, which can place a lot of pressure on newcomer investors.
With the lift of the General Solicitation ban, the online investing (or “equity crowdfunding”) industry has emerged to give investors direct access to the private market. Online access is enabling a long-overdue evolution of the private investing industry, since it’s no longer restricted to personal referrals and closed-door pitches.
[Editors’ Note: the author uses the term “equity crowdfunding” above to describe all online platforms that facilitate equity investments in non-public companies. This is, indeed, how people generally use the term. However, as explained by Jonathan Friedland in The Investor’s Guide to Alternative Assets: the JOBS Act, “accredited investing,” and You, “the term ‘crowdfunding’ is only correctly applied to the Title III context (that is, Crowdfunding Portals through which anyone can be an investor) and not to Reg D (Title II) Equity Offering Platforms, which are limited to accredited investors.”]
Online platforms improve on the referral and association models by eliminating their inherent reliance on geographic proximity and broadening your deal flow to include opportunities around the country. They also give individual investors more personal control over which types of opportunities are streamed to them. (Want to invest in later-stage companies with track records of returns? Partner with a platform that specializes in those types of offerings. Interested in commercial real estate? Register for one that offers real estate deals.)
Additionally, online investing is injecting the private market with greater transparency. The top-tier platforms protect investors by pre-vetting opportunities and conducting background checks on issuers. They also supply investors with the resources they need to make their investment decisions (e.g., company history, subscription documents, investment terms and return projections) in one portal, typically with low investment minimums.
However, while there are many out there, not all crowdfunding platforms are created equal. Investors should be cognizant of their differences before relying on them for deal flow. Some function only as listing services, conducting no due diligence and facilitating no actual investment transactions; others are more like online VCs, presenting only deals in which the platform has a vested financial interest. Investors should research a platform’s partners, products, and eligibility criteria before becoming an active investor. At minimum, investors should ensure that any platform they sign up for is conducting regulatory compliance checks on each opportunity.
Lastly, it’s every accredited investor’s responsibility to understand what they’re investing in, how they’ll earn returns, and how risky the investments are when reviewing opportunities in their deal flow—no matter how they learn about them. Along with deal flow, education and awareness are key components to successful private investing… and no colleague, network or portal can substitute for an investor’s own research.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: What is a “Private Fund?” and Private Offering Exemptions and Private Placements. This is an updated version of an article originally published on November 4, 2014.]
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