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Privatize your portfolio
For market refugees, private firms are an intriguing haven
Published By: Canadian Business
Date: August 5, 2002
Section: Investing
By: Jason Kirby
Internet Link: Canadian Business
Private placement investments—the term conjures dark images of fly-by-night hucksters,
worthless shares in dead-in-the-water start-ups and red ink splashed all over your portfolio.
Come to think of it, though, that pretty much sums up the stock markets of the past two years.
So if you’ve got heaps of chutzpah—and coinage—maybe it’s time to consider taking your money private.
The reason: investing in private companies is sometimes better than trusting your bucks to public markets
Let’s make a few things clear first. Private placements do have a shady side—just like all investments.
But in private equity, there’s far more onus on investors to do their own research. And they aren’t for
the penny stock crowd. Typical placements start at $50,000, and regulators have laid down steep minimum
net worth requirements. Finally, if you think the Toronto Stock Exchange is illiquid, private equity is worse.
Finding buyers for your shares, if you have second thoughts, will be hard.
For those who can overlook all that—and the evidence says more and more private investors in Canada are
doing it every year—read on. “If you’re cash rich, it’s a good time to invest in private companies,”
says Jason Sparaga, president and CEO of CCFL Spara Partners Inc. of Toronto, an investment banking firm
primarily for the private equity market. “It’s grown as people have pulled their money out of the public
markets.” Sparaga says he’s getting three calls a week from individual investors looking to take part in deals.
No wonder. Consider the long-term returns. According to research prepared by Bain & Co., private equity
firms have consistently outperformed the S&P 500 over the past 20 years, returning 18.9% to investors versus
12% from the S&P 500. The short-term data is even more impressive —from 1995 until 2000, private firms returned
32.4%, versus 16.5% from the S&P 500.
Sparaga dispels a common myth about private investment: this isn’t venture capital, throwing money at a
propellerhead with a new widget. Many deals he’s worked on over the past year have involved midsize, unsexy—and
profitable—manufacturers. His current financings includes a food services company with sales of $150 million
and gross margins of 36%; the owners want money to grow through acquisitions.
Why chance the risks of private placements? For one thing, company management actually listens to shareholders.
You can meet them yourself and make your own judgments about them, says Sparaga, rather than relying on analysts
who are chummy with the CEO. And if the deal is structured right, you’ll still get quarterly financial reports.
Dan Friedberg, a vice- president at Bain & Co.’s private equity division in New York, says managers at
private firms often return better value to shareholders than their public market counterparts do. Friedberg
recently completed a study of 2,000 private equity transactions. He found managers at private companies aren’t
slaves to the next quarter. “Focusing on quarterly results clouds the long term and sometimes actually fosters
making the wrong decisions,” he says. In the best private firms, every management decision revolves around
increasing shareholder returns; executives in publicly traded companies must contend with other distractions,
like bloated regulatory bureaucracies and analysts, not to mention the lure of boosting the stock to cash in options.
Not all private firms are good, Friedberg says, but the good ones are better than most public companies.
And now is a good time to get into the private equity market. Sparaga says banks, suffering from loan
defaults, are telling midsize firms they need to bring in more equity. And an increasing number of public
companies are looking for financing to buy back all their shares. But it can take months to find potential
investments—regulators prohibit private companies from broadly advertising for investors. If you’re serious,
Sparaga suggests calling your broker, accountant or lawyer, who should be able to direct you to firms like his.
Sparaga is also president of the Toronto chapter of the Association for Corporate Growth, which attracts
investors and companies seeking funding.
Of course, to invest in private companies, you need to have a liquid net worth of $1 million. “But it should
be buyer beware,” says Sparaga. “As it is, it’s almost communist.” That’s probably going a bit far, but he makes
a pretty good point: there are no net worth requirements to spend $50,000 on a car, even if it is a lemon, so why
shouldn’t you be allowed to invest the same amount in a private company? For now, though, getting rich—or losing
their shirts—on private placements is an option reserved for millionaires.
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