Investing in a private company: shares, rights and risks

01

What does it mean to invest in an existing private company?

In simple terms, investing in an existing private company means acquiring an ownership interest in a business that is not publicly traded. The shares may be newly issued by the company, or they may be acquired from an existing shareholder.

Buying shares makes you a shareholder, with the rights, restrictions and economic terms attached to them. Lending money instead makes you a creditor: your claim for repayment comes from the loan, not share ownership.

If you allocate capital to an investment fund or strategy, your economic exposure is primarily to the capital allocated and its investment results, subject to the relevant vehicle or mandate. If you buy shares in the company itself, you own part of the business. These are not different versions of the same investment.

They are different economic exposures.

A purchase of existing shares from a current shareholder is commonly described as a secondary transaction.

02

Build, buy or back?

Starting a company means initially choosing its product, people, and working methods within legal, resource, shareholder, and funding constraints. Buying a whole company can give you control, but requires examining inherited debts, contracts, and problems. Neither choice grants unlimited freedom.

A minority or strategic investment sits somewhere else. You may not be buying control. You may be buying a stake in a business that already knows what it is doing. That can be attractive. It also creates a different set of risks.

03

Experience: what can the company do today?

Imagine a company that has spent five years building its systems. A new investor can fund engineers, computers, data and advisers. Those resources let a new team start work, but do not ensure that it already knows how to solve the problems the company encountered over those five years.

Experience can produce practical checks: noticing a missing input before starting a calculation, for example, or knowing how to resume interrupted work without duplicating it. To assess that experience, ask for examples of problems the team has solved and solutions that still work today.

Check who can maintain those solutions. If only the founder knows how they work, the company may struggle when that person is unavailable. Written procedures, maintained software and colleagues who can carry out the work make this dependence easier to assess.

The useful question is what the company can do today, and how reliably it can keep doing it.

04

What are you actually buying when you buy shares in a private company?

You are not personally buying the company’s computers, software, customer relationships or intellectual property. The company owns its assets. The shares give you an ownership interest in the company, with whatever economic and governance rights belong to that class of shares and to the relevant agreements.

So the useful question is not:

What assets does this company have?

It is:

What can this company do because those assets, people and processes exist together?

A database by itself may be worth little. Software without the people who understand it may be worth less than expected. A founder without systems may represent concentrated key-person risk. A sophisticated operating process may still be easy to reproduce if neither intellectual property nor other barriers protect it.

05

Capital to keep operating or expand the business

There is an important difference between:

a company that must raise money to keep paying salaries and bills, and one that can already cover those costs itself. In the first, new capital buys more time to make the business sustainable. In the second, it can fund an additional project, such as hiring two developers or selling a product in another country. Asking what the money will pay for helps distinguish the two situations.

Needing new capital does not, by itself, tell you whether a company is good or bad. A business that can fund itself may still have serious problems; one raising money may have a credible plan. The need for funding changes how long the company can continue and what it must achieve with the money.

To assess dependence on new funding, compare available cash with committed spending and payment deadlines. Do not assume buyer and seller understand the funding need equally well. If operations can continue without your contribution, the next question is:

Why should this particular shareholder be part of the company?

06

Why would a company that does not need capital accept an investor?

A new shareholder may also contribute to the company’s work. For example, they may know potential customers, help meet the requirements of a new market or bring experience of running a business. They may also accept that their money will remain invested for years. The value of these contributions depends on the company’s actual needs and the agreements between the parties.

A shareholder may want to sell some shares: the purchase price goes to that seller, not automatically to the company. Subscribing for newly issued shares instead puts money into the company. Reducing dependence on the founder also requires capable replacements, documented procedures, and delegated powers. Changing the shareholder list alone does not achieve that.

So a company can rationally decide that it does not need outside capital and still conclude that the right owner may be worth having. Those are not contradictory positions.

08

What should an investor look for in an existing private company?

A useful starting point is one question:

What exists here that would be difficult to recreate?

A high cost does not necessarily make something hard to reproduce. Compare an office furnished with commercially available products with specialist software that only two people know how to maintain. You can request quotes for the office; for the software, establish what knowledge is needed, whether it is documented and what work would be required to recreate it.

Apply the same questions to data, licences, research and customer relationships. Years of work alone do not establish an advantage. Then ask:

• Does the company own that advantage, or does one individual own it?
• If the founder were unavailable tomorrow, what would remain?
• Code?
• Documentation?
• Processes?
• Contracts?
• Data?
• People capable of continuing the work?
• Institutional knowledge?

A company can be founder-led without being founder-dependent. That distinction matters enormously to an outside shareholder.

For an IP ownership review, see WIPO’s guide to preparing for IP due diligence.

09

Dependence on funding and on the founder

What happens to this company if no new investor appears?

Check whether available cash and expected receipts cover spending and debts as they fall due.

If operations can continue without new investors, that answers a question about funding. You still need to establish who could keep them running:

What happens if the founder becomes unavailable?

Check who has the skills, access, and authority needed to continue the work.

If almost everything would stop, the company depends on a person even if it has enough money. The first check concerns cash; the second concerns replacing the person who performs and directs the work.

10

Is a minority stake really ownership?

Yes: owning a minority of the shares still makes you a shareholder. The percentage measures your share of the total number of shares, but does not by itself describe your powers, possible payments or ability to sell. Before accepting a stake, read the share rights and agreements:

• A percentage of which share class?
• With what voting rights?
• What information rights?
• Can the company issue more shares and dilute you?
• Do existing shareholders have the right to subscribe for newly issued shares before they are offered to others (pre-emption rights)?
• Are there restrictions on transferring your shares?
• Can other shareholders force a sale (drag-along)?
• Can you participate if they sell (tag-along)?
• Is there a board seat or observer right?
• How are dividends decided?
• What happens if additional capital is needed later?

Owning 10% of the shares does not automatically entitle you to withdraw 10% of bank cash, approve 10% of decisions, or collect 10% of a theoretical valuation. Examine voting, information, dividend, and sale rights under the applicable law, share class, and agreements.

For the UK context, see GOV.UK’s guidance on shareholders and share classes.

11

Private-company shares can be difficult to sell

Public markets make one thing easy to forget:

ownership and liquidity are different things. A listed share usually has a visible market price and a mechanism for selling. A private share may have neither. There may be transfer restrictions. Other shareholders may have rights of first refusal. The company may need to approve a transfer.

There may simply be no buyer when you want one. An investor should therefore never confuse:

What is this stake worth in theory?

with Who would actually buy it from me, when, and under what terms?

A private company can become far more valuable while its shares remain difficult to monetise. An investment can also fail completely. Illiquidity is not an administrative inconvenience. It is part of the risk.

For broader risk context, see the FCA’s guidance on high-risk investments.

12

How should a private company be valued?

There is no single answer. A valuation is not simply the founder’s preferred number. It is not whatever the investor can afford. And it is not automatically a multiple copied from a listed company. The relevant value depends on what the company is, what it can become, how uncertain that future is, what rights the investor receives and how realistic an eventual exit may be.

For an operating company, profits, cash received and paid, assets, growth and comparable sales may help assess value. For a young technology company, much of the proposed value may depend on products and sales that do not yet exist. Ask which future revenues and costs the valuation assumes, and what supports those assumptions. Research or intellectual property may contribute to future products; the price of the company’s physical assets alone does not capture those possibilities or their uncertainty.

Ask how money would be divided if the company were sold or liquidated. Some shares may have priority over others: these are liquidation preferences. Other shares may convert into another class under specified terms. Also consider shares that could arise from options or convertible instruments: including them in the total gives a fully diluted ownership calculation. A value for the whole company therefore does not tell you what one shareholder would receive; the share-class rights and applicable agreements matter.

For share terms and dilution in the UK context, see the British Business Bank’s guide to term sheets.

Valuation is therefore partly a mathematical problem and partly a problem of uncertainty. A precise number does not make an uncertain assumption precise.

13

Owning shares in a company and allocating capital to its strategy are different investments

This distinction becomes especially important with investment, trading and quantitative companies. Suppose a company has developed an investment strategy. An investor might allocate capital to that strategy or acquire equity in the company that developed it.

In the first case, you allocate a sum to a strategy: gains and losses depend mainly on how it is invested, with the costs and rights set by the arrangement. In the second, you buy shares in the company that developed the strategy. You become a shareholder with the rights attached to those shares; the holding’s value depends on the whole business.

The economic value of the shareholder’s stake therefore depends on the business as a whole: its intellectual property, future products, research capability, costs, liabilities, people, governance and future commercial decisions. The company, rather than the shareholder personally, owns its assets.

A strategy can contribute to the company’s value. Buying shares still gives you rights in the whole company, rather than a personal account whose result tracks that strategy alone.

14

How do you find good private companies if they are not fundraising?

This is harder than browsing a list of funding rounds. By definition, companies that are not actively seeking capital may not appear on fundraising platforms or advertise themselves as investment opportunities. That means the search has to begin somewhere else.

Compare the business description with the available documents. Do contracts give the company rights to the product it presents? Do its accounts explain how it pays its expenses? Then investigate whether it could keep operating without a new investor. A polished presentation does not answer these questions.

UK company identity and filings can be checked through Companies House. A public filing is a starting point, not proof of operating quality.

15

What should make an investor cautious?

Urgency should. So should vagueness. A private-company investor should become more cautious when the economic story depends mainly on adjectives, when intellectual property ownership is unclear, when historical performance cannot be separated from hindsight, when the founder and company are legally or operationally indistinguishable, when valuation is defended primarily by distant possibilities, or when basic shareholder rights cannot be explained clearly.

A plan may depend on new funding, a client, an approval or one person’s work. For each scenario, identify the event that must happen, the documents supporting it and what would happen to cash and operations if it did not occur.

16

What does good due diligence actually try to discover?

Compare the company’s claims with corporate records, intellectual-property contracts, accounts and results you can examine. Record discrepancies and request missing evidence before drawing a conclusion. The following questions cover different parts of this examination.

• Do the company’s legal records match its public presentation?
• Does the company own its intellectual property?
• Do reported results match the supporting evidence?
• Does the operating process exist outside the founder’s head?
• Do the economics still make sense under less favourable assumptions?
• What would happen after a bad year?
• What would additional capital actually change?
• Why does the company want another shareholder?
• And why should the investor want to become one?

The purpose of due diligence is not to remove uncertainty. It is to understand which risks and uncertainties you would be taking on.

17

Record what each proposed expense would change

Use the distinction in section 5 to examine one proposed expense at a time. Copy these four fields into your notes and complete them with the company’s documents:

1. Decision: what expense or project needs approval, and who will receive the payment?
2. Available document: name the budget, quote or agreement that supports the amount and timing.
3. Missing information: what cost, funding source or expected result still needs checking?
4. Responsible person: who must supply the missing information and who can approve the expense?

For example, hiring two developers requires more than an available sum: identify the work, its cost and deadline, and the evidence of customer demand. If the money instead pays an existing shareholder for shares, record that recipient; the payment does not fund the proposed work.

18

Agree on capital, work and the new shareholder’s rights

One person may have developed a product; another may have money but no wish to build a product themselves. Before becoming shareholders together, they need to agree which activities to fund, who will do the work and what rights the new shareholder will receive. Money and expertise can support the same project when the agreements and both parties’ needs allow it.

19

Record what you could actually verify

After the search described in section 14, start with one claim: what has the company built, and what supports it? For a product, try the available functions and check the company’s rights. For research, examine accessible data, methods and results. Name any missing document and the conclusion you must leave open until it is available.