The Basics of Investing in Private Companies: A Q&A

While private investments in early-stage companies have the potential for significant upside, they also carry significant risks. If adequate documentation is not available, proceed cautiously, if at all.

In this 4-part series, we’ve discussed how, due to their deep expertise in and understanding of the life sciences, physicians are in an excellent position to invest in the biotech and healthcare industry — not simply in mature public companies, but in early- and mid-stage private entities, some of which have significant potential for appreciation.

We also addressed some healthcare subsectors where we expect to see growth. Lastly, we outlined different ways of investing in early and mid-stage companies, and evaluated the risks and rewards.

In this, the final article in our series, we respond to reader questions.

What is the difference between public versus private companies?

A public company is one that has “gone public” via an initial public offering (IPO) and its shares (aka securities) are available on a stock exchange (such as NYSE, NASDAQ) or over-the-counter market (OTCBB). Public companies have many more investors than private companies and are subject to stringent reporting requirements by the Securities and Exchange Commission (SEC). Anyone can purchase shares of a public company, regardless of income status.

Private companies are firms that are owned by a limited group of shareholders. They can be early-stage startups, or large, established companies. Private companies are not listed on any exchange and shares are not available to the general public. Many investors are interested in investing in early- to mid-state private companies because the opportunity for upside can be significant. However, unlike in a public company, the shares are generally illiquid and cannot easily be sold.

For the most part, in order to invest in a private company, one must be an accredited investor. To be accredited, an individual must make over $200,000 a year individually or $300,000 combined with spouse, or have a net worth of $1 million, not including their primary residence.

What are some sectors to watch in biotech and healthcare investing?

There are several potential growth areas in biotech and healthcare investing, including regenerative medicine, health IT-bioinformatics, orphan disease treatments, precision medicine in oncology, and genomics.

Regenerative medicine has far-reaching implications for treating numerous devastating and costly diseases. Digital health and health IT have already created administrative efficiencies unimaginable in the paper-based offices of the past; new technologies involving mobile, digital, data, and predictive analytics are showing similar promise for improving healthcare delivery. Once an area with limited drug development, drugs targeting orphan diseases have become hugely profitable thanks to a favorable economic climate for research, development, and marketing products for rare diseases.

For cancer care, significant strides have been made in precision medicine and genomics. Precision medicine, guided by the use of gene sequencing, has tremendous promise to improve cancer care. Genomics provides oncologists with detailed information about the molecular profile of each tumor, and possible targeted treatments to address the disease.

I’m interested in finding early-stage biotech companies to invest in, but don’t know how to find them. How can I learn about opportunities to invest?

You can join angel investor groups or put your money in venture capital or private equity firms that are involved in the biotech and healthcare space. These organizations have contact with early-stage companies that are seeking funding.

Angel groups provide you direct access to invest in early stage companies; however, investment minimums can be $25,000 to $100,000 per investment and they are often limited to deals in the group’s particular geographic region. Depending on where you live, there may be very few deals available, unless you’re located near a major biotech or life sciences hub.

Venture or private equity groups raise pools of funds from investors, which they then use to invest in individual companies. However, you must have sufficient amounts of capital to make the minimum requirement (usually upwards of $250,000 to $1 million). In addition, these firms typically charge a management fee (~2% of assets managed) and performance fee (~20% of profits).

Another (and new) way is online investing. One of the advantages of this method, versus traditional venture investing, is that minimum investments can be as little as $1,000. Crowdfunding platforms enable private offerings to take place online. These platforms bring together a community of high-net-worth, private investors and match them directly with companies seeking capital, regardless of geographical location. For investors, funding platforms are a valuable tool for locating and evaluating companies that are raising capital.

Platforms that specialize in healthcare-related enterprises can include startup companies focusing on products or services, such as new drugs, devices, diagnostic equipment, healthcare IT products and services. Some companies may be very early stage; some may already be in Phase III clinical trials or have products on the market.

How does crowdfunding work, and what should I look for in an online platform to ensure my investment is safe?

When you first visit a crowdfunding platform, you can use it to browse information about the issuing companies. If you decide to invest in a particular opportunity, your money will be held in escrow at a third-party custodian. Typically, there is a minimum investment threshold before a deal can close. If a deal hits the minimum investment target, the investment goes through as the money gets distributed to the company and investors are issued shares in the company. If the deal does not hit its minimum investment target, your money will be returned to you (no investment made).

Before investing with an online crowdfunding platform, ensure that it has measures in place to protect your money, including the use of escrow accounts and minimum investment targets. Also, be sure to conduct adequate diligence on each deal prior to making an investment.

While private investments in early-stage companies have the potential for significant upside, they also carry significant risks, including the possibility that you will lose all the money you invested. If you are not provided with enough documentation to make an informed decision online, be sure to request necessary documentation prior to investing.

If adequate documentation is not available, proceed cautiously, if at all.

Rania Nasis, MD, is a Managing Director at Poliwogg, a financial services firm transforming healthcare investing. Its online investment platform enables accredited investors to access and directly invest in innovative healthcare and life sciences companies. Contact Dr. Nasis at rnasis@poliwogg.com.

Private investment marketing and other broker-dealer services are currently offered through a partnership with SDDCO Brokerage Advisors, LLC, member FINRA/SIPC ("SDDCO-BA"). Poliwogg and its affiliates are independent and unaffiliated with SDDCO-BA. All such services offered by Poliwogg-associated persons are done so in their capacities as registered representatives of SDDCO-BA.