How to Buy Privately Held Stocks

Investing in private companies is harder and riskier than buying publicly traded stock.

Investing in private companies is harder and riskier than buying publicly traded stock.

Most companies are privately owned. Purchasing privately held stocks requires more work than simply calling up your broker or logging into your online account. The only way to buy privately held stocks is person-to-person, either from the company directly or from a shareholder looking to get out. Because you can’t sell your privately held stock at a moment’s notice, you might need the help of professionals to make sure you’re not getting into trouble.

Find a Seller

Shareholders of a close corporation typically have a substantial connection to the business in one way or another -- board members, employees or family members, for example. That’s not a requirement to buy in though. If you’re eager to invest in a privately held corporation and you’re willing to invest in a stranger’s business, then you need a way to find someone who’s selling. Public accountants, business attorneys and bankers typically are in touch with substantial networks of small-business owners, and might introduce you to someone looking to sell. Otherwise you could try approaching the business directly and let the owners know your goal.

Terms of the Stock

Buying into a private business often puts you in one of the most uncomfortable ownership positions -- minority shareholder. If you don’t have substantial connections to the other owners they might not consider your interests as much when making decisions. You want to make sure you have some assurance that you can get something from your stake in the company because you can’t readily get out of a bad situation. Examine the terms of the stock and the corporate articles and bylaws to see what protections come with the shares. Some corporations include standing buy-back provisions that allow shareholders to sell some stock back to the company for a formula-based value, for example.

Shareholder Role and Responsibilities

Defining each shareholder’s role and responsibilities in clear terms preempts confusion and disagreements down the road. Especially if you have no substantial connection to the company, you want to clarify what obligation the majority shareholders are under to issue dividends, and what limits prevent unreasonable raises to employee-shareholder wages. State law governing the corporation might offer you some protections as a minority shareholder, but entering an agreement with the other shareholders can save you the trouble of litigating to get those protections.

Agree to a Price

When you’ve done all your due diligence and investigation and are ready to commit to becoming a shareholder in a close corporation, it’s time to negotiate price. Unlike publicly traded stock, setting the price is up to you. You can use any number of valuation methods you like -- multiplying the book value or earnings forecast by a set number, adjusting future cash flows for inflation and the inability to easily sell the stock, or hiring an independent expert to do it for you. Ultimately, you have to offer a price that the person selling is willing to accept.

 

About the Author

Sean Butner has been writing news articles, blog entries and feature pieces since 2005. His articles have appeared on the cover of "The Richland Sandstorm" and "The Palimpsest Files." He is completing graduate coursework in accounting through Texas A&M University-Commerce. He currently advises families on their insurance and financial planning needs.

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