How To Invest In Socially Responsible Companies
More than ever before, investors are making an effort to put their money into companies representing the values they adopt. Socially responsible investing means paying attention to a companys social and environmental activities to ensure they align with yours.
How can you tell whether a company is socially responsible? Its hard to know whether a company genuinely has these values based on their word alone. Besides doing your research on a company, you can use robo-advisors and investing apps to determine a companys social responsibility.
A Slow Motion Version Of The Death Penalty: Why Harvard Shouldnt Invest In Prisons
In early 1971, Terrell Don Hutto was the warden on a cotton plantation the size of Manhattan. About a decade later, hed use lessons learned on the plantation to create something new, crude, and often in Harvards portfolio the worlds first corporate prison.
Hutto began his career in incarceration on the Ramsey Prison Farm in the 60s.
In many ways, Ramsey was a typical Southern prison. After slaverys abolition, former Confederate states realized the 13th Amendment handed them a path forward. Neither slavery nor involuntary servitude would exist in the U.S., it declared, except as a punishment for crime. So states with economies bruised by emancipation eyed prison labor as new fuel for the old slave economy. They purchased plantations, attached them to prisons, and began filling them with Black men many for crimes, like selling crops without a white persons permission, invented to incarcerate them.
When Hutto ran Ramsey, every Black person it imprisoned was forced to work the cotton plantation, plus a fraction of the prisons few white prisoners. Dusk to dawn, they picked cotton across sprawling fields. None were paid. Slow hands in the field often meant solitary confinement or being fed a punishment diet, which one man testified he lost 30 pounds on. Academics flocked to Texas to document the old slave songs, reaching back to West Africa, that rang out on its prison plantations.
Luckily, this history didnt shake investors.
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Pros And Cons Of Private Equity
Private equity offers several advantages to companies and startups by providing access to funding from sources like venture capital instead of using funding from traditional financial instruments, like high-interest bank loans.
If a company is de-listed or removed from an exchange, private equity financing provides growth strategies away from the public markets without the pressure to sustain earnings for investors.
Private equity has unique challenges as it can be difficult to liquidate holdings in private equity. Unlike a transaction on an exchange, a firm must search for a buyer to sell its investment or company.
Pricing of shares for a company in private equity is determined through negotiations between buyers and sellers and not by market forces. The rights of private equity shareholders are decided on a case-by-case basis through negotiations instead of a broad governance framework that typically dictates rights for their investors in public entities.
Learn The Language Of Alternative Investments
Before diving into private equity investment, its important to understand the language and field of alternative investments. Alternative investments are any investment besides stocks, bonds, and cash. Private equity is one of the many strategies that make up the alternative investment asset class.
To gain foundational knowledge, explore some of Harvard Business School Onlines blog posts on alternatives:
Also, consider taking the online course Alternative Investments for a comprehensive understanding of the field and how to analyze private equity, real estate, hedge funds, and debt investments.
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Risks Associated With Pre
While investing in Pre-IPO companies come with substantial gains, these shares can also be quite risky. Some of the risks associated with Pre-IPO shares include the following
Less Liquidityâ Although stock tokenisation has been adopted as a way of enhancing the liquidity of Pre-IPO shares, most of these stocks are generally less liquid. There is no guarantee that the Pre-IPO company you invest in will be acquired or listed in a stock exchange. As a result of failure to augur well in the market, potential investors might not be interested in the company. This means that the current investor or shareholders might struggle to sell their shares in the foreseeable future, without having to lower their value below the current market prices.
Capital Lossâ If the company you invest is not acquired or listed in a stock exchange, you are likely to lose your capital investment in its entirety. Unfortunately, these listings and acquisitions are not guaranteed. Also, Pre-IPO companies are subject to bankruptcy due to a lack of future funding or operational failure. This might lead to partial or total capital loss.
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How Private Equity Works
Lets say you invest $1 million through a private equity firm . The private equity firm would put your money in a private equity fund along with money from other investors and invest the pool of money in various private equity instruments, such as buyouts or venture capital .
In addition to meeting the minimum investment requirements of private equity funds, youll also need to be an accredited investor, meaning your net worth alone or combined with a spouse is over $1 million or your annual income was higher than $200,000 in each of the last two years.
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Why Invest In Private Equity
Institutional investors and wealthy individuals are often attracted to private equity investments. This includes large university endowments, pension plans, and family offices. Their money becomes funding for early-stage, high-risk ventures and plays a major role in the economy.
Often, the money will go into new companies believed to have significant growth possibilities in industries such as telecommunications, software, hardware, healthcare, and biotechnology. Private equity firms try to add value to the companies they buy and make them even more profitable. For example, they might bring in a new management team, add complementary companies, aggressively cut costs, or spin off parts of the business that are underperforming.
You probably recognize some of the companies below that received private equity funding over the years:
- A& W Restaurants
Without private equity money, these firms might not have grown into household names.
Are Private Equity Firms Regulated
In 2015, U.S. legislators proposed increased transparency in the private equity industry due largely to the amount of income, earnings, and salaries earned by employees at all private equity firms. As of 2021, legislators have pushed bills and regulations allowing for a bigger window into the inner workings of private equity firms, including the Stop Wall Street Looting Act. However, other lawmakers on Capitol Hill are pushing back, citing limitations of the Securities and Exchange Commissionâs access to company information.
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Where To Find Venture Capitalists
The first step to find venture capital is to make a smart introduction to the venture capital firm the founder is interested in meeting. Venture capitalists rely heavily on trusted connections to vet deals.
Founders shouldnât try to contact as many people as possible they should try to find venture capital firms that are the best possible fit for their deal.
The more closely aligned the founder is with the needs of the venture firm, the more likely theyâll find venture capital firms willing to write them a check.
Founders should do extensive research both online and through existing networks ahead of time in order to determine what types of investments a firm makes, as well as whether or not they have any connections with that firm.
Every pitch to a venture capital firm starts with an introduction to one of the private investors at the firm. It helps to know the exact profile of a venture capitalist to know which level of introduction makes sense.
Typically itâs starts with an introduction to an associate and then founders can work their way up to the full partnership.
Nothing But Table Scraps
Its normal now for private equity to take 80%, 90%, 95%, or even 100% of the profits at the time of the IPO. So little upside is left over for normal investors.
Sadly, this isnt going to get better anytime soon. Why? The world is awash with cash right now. Venture capitalists and private equity like to call this dry powder.
As you can see in the chart below, institutional investors have been sitting on more than $1.5 trillion in dry powder. Thats more than Australias annual GDP. There has never been this much capital available for investment in history.
And right now, stocks are hovering near all-time highs. The majority of this money will not be put to work in public companies as a result.
The low interest rates and overall poor performance of hedge funds have resulted in high-net-worth individuals, sovereign wealth funds, family offices, and institutional wealth pursuing higher returns through other means like private equity investments.
Put simply, the bulk of this $1.5 trillion will be put to work in the area with the highest return potential: private companies with high growth potential.
However, this has caused a major distortion in the private markets.
There has been so much capital available to pursue private equity deals that the competition for any high-quality deal has been tougher than ever. Not only has it become difficult to allocate capital into private equity investments, but it has also become even harder to do so at compelling valuations.
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Companies Part Of The Prison Industrial Complex
A prison stocks list can be found on Prison Free Funds, an organization dedicated to identifying publicly traded companies involved in the prison industrial complex and the border industry. They also provide tools to help expose how much of your mutual fund investments and 401 is invested in the complex.
For example, Acadia Healthcare Co is a healthcare company that provides residential re-entry programs. Itâs also involved in the border industry by detaining a small number of unaccompanied immigrant youth, Prison Free Funds writes. Aramark provides food, commissary and other goods, as well as prison labor, to the prison industrial complex. SuperCom Ltd. is another company involved in the complex. The company owns the California-based Leaders in Community Alternatives , an electronic monitoring and community corrections company, providing community corrections and e-incarceration to the prison industry, Prison Free Funds writes.
Investing in prison stocks is a personal choice however, if you would like to avoid it, itâs essential to understand that the complex extends further than private prison operators. Research is critical to wise investments.
How To Invest In Startups
Not all investors want to take the risk that comes with investing in startups. However, that doesnt make startups a losing option for everyone.
U.S. News & World Report says that, when backing a startup, you probably wont see a return on your investment for at least ten years. Make sure that if you decide to invest in a startup, you have time to wait and a higher risk allowance.
Andaccording to data from Small Business Trends, about 44% of small businesses fail by their fourth year. That lowers the likelihood of a successful investment on your part and can mean significant losses.
Before you invest in a startup, research the company and its business plan. Talk to the owners just as you would with an established private company, and ask questions about their operating model and whether they have other investors.
You can typically invest in startups in a few ways:
- Crowdfunding online.
- Pre-IPO opportunities.
- Buying equity with a local company.
Each of these methods can build your investment over time, but their success often depends on how well the company you select performs.
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The Strategic Secret Of Private Equity
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The huge sums that private equity firms make on their investments evoke admiration and envy. Typically, these returns are attributed to the firms aggressive use of debt, concentration on cash flow and margins, freedom from public company regulations, and hefty incentives for operating managers. But the fundamental reason for private equitys success is the strategy of buying to sellone rarely employed by public companies, which, in pursuit of synergies, usually buy to keep.
The chief advantage of buying to sell is simple but often overlooked, explain Barber and Goold, directors of the Ashridge Strategic Management Centre. Private equitys sweet spot is acquisitions that have been undermanaged or undervalued, where theres a onetime opportunity to increase a businesss value. Once that gain has been realized, private equity firms sell for a maximum return. A corporate acquirer, in contrast, will dilute its return by hanging on to the business after the growth in value tapers off.
Public companies that compete in this space can offer investors better returns than private equity firms do. Corporations have two options: to copy private equitys model, as investment companies Wendel and Eurazeo have done with dramatic success, or to take a flexible approach, holding businesses for as long as they can add value as owners. The latter would give companies an advantage over funds, which must liquidate within a preset timepotentially leaving money on the table.
Research Their Operating Models
A companys operating model and financials are the most transparent ways to predict future growth and business performance. According to the Corporate Finance Institute, a financial model can be as simple as a spreadsheet that forecasts a companys financials based on its history.
You wouldnt buy a businesss product if it didnt work. The same concept goes for the company itself. If it does not have a successful operating model or show positive growth, its not a worthwhile investment.
A good financial model should show:
- Budgeting capability.
- Asset acquisitions.
- Allocation of funds.
This model should also show you where the company gets its funds, its market value, and whatever critical resources needed for it to achieve its business goals.
On the other hand, the companys operating model should tell you how it utilizes its various components to create success. Those can include employee skills, technology, company policies, and organization.
Knowing about a companys robust operating model shows whether it can meet challenges and continue to provide quality products or services. The model also indicates whether the company will use your investment wisely.
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Advantages Of Investing In Private Companies
Many investors choose to open a self-directed IRA for the advantages this investment account offers, including tax advantages and portfolio diversification.
- Tax advantages: A self-directed IRA offers the same tax advantages you can get from a standard IRA, such as tax-exempt or tax-deferred growth.
- Portfolio diversification: Diversifying your portfolio can help mitigate the risk to your retirement funds. By investing in private companies, you can disperse your money into asset types other than paper assets, such as bonds and stocks. This protects your savings from significant loss.
- Growth potential: Private companies tend to have great potential for growth, especially start-ups. Compared to buying shares in a listed company, your return on investment can be higher, as there is more room for growth. A private company is usually more agile than a PLC and can quickly change direction if concerns are raised.
To enjoy these benefits, consider investing in private companies with your IRA.
Private Equity Vs Public Equity
Public markets provide investors the opportunity to invest in public equity such as stocks and bonds on a market exchange with transparency and liquidity. Public equity investments are readily available for all types of investors.
Private equity is not traded on a public exchange, often requires and long investment time commitment, and provides a low level of liquidity. Investors in private equity are accredited investors, defined by investment regulations with a specified net worth.
Investment in private equity is viewed as riskier than investing in the public marketplace as private equity investments are less regulated than public investments.
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Reasons Why People Invest In Companies Directly
There are plenty of reasons why people invest in companies directly rather than just investing in public stocks.
Here are some of my favorite reasons:
Investing in a company is a great way to build yourself personally while also enhancing your financial future. Even if things go the wrong way and you lose money, youâll end up learning a lot along the way.
What Are The Advantages Of Investing In A Private Company
More potential for growth
Many private companies, particularly start-ups, have a lot of potential for growth. The return on investment can be a lot more significant compared with buying shares in listed companies which are normally at a far more advanced stage in their business life cycle and therefore have less room for growth.
Furthermore, private companies are generally more agile than PLCs and can change direction quickly, e.g. in response to concerns raised by smaller shareholders and investors.
Business involvement
Investors in small private companies are more likely to be able to communicate directly with the business owners and senior management team.
They will often be able to become actively involved with the business and will have more influence in a small business compared to making the same level of investment in a large PLC.
Negotiation
A potential investor in a small private company will generally be in a better position to negotiate a specific required return on investment.
They have more bargaining power compared to a purchaser of shares in a PLC, since they will be a bigger fish in a smaller pond.
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