OT: lesson learned from a private investment

In 2014, my wife and I invested in a startup business. It is an industry I know well - the business is asset light, and the balance sheet/financials are easy to analyze to determine how the business is doing. The terms of the investment were amazing. A loan to the company at 10% interest over 3years, for 15% equity, with the equity remaining in place even after the loan was paid off.

The initial phases of growth were strong and predictable, but the business hit a natural plateau a year ago, and it hummed along quite nicely with strong consistent cash flows consisting of predictable recurring revenues, limited competition, rare one-time expenses, etc.

To get to the next level of growth, the business required a moderate amount of additional investment - staff, equipment, marketing/social media blitz, etc.

Simultaneously, one managing partner needed to depart for personal reasons and she sought the company buy back her shares. She preferred an immediate lump sum, but also offered to take a stretched out payout over a longer period (in a higher amount). The other partners preferred the former to minimize total impact to the company; however, the company had limited cash on hand because it was still paying back investors- even though cash flows were strong, the company paid a lot out back to investors - a payment plan over 12 months would easily buy out the partner in short order.

In discussing the buyout plan with the managing partner and, in reviewing the business’ current financials, the managing partner gave me an update about the recent uptick in business, the results of the marketing campaign, the increased recurring revenue, and their raised guidance for the rest of the year.

It was an absolute no brainer to offer some cash to help speed up the departing partner’s payout in exchange for additional equity in the company. I had just “added to my position”.

This is a private company. There is no share price. If this company were public its share price would likely have gone up on the news. Why wouldn’t I add to my position there too? Why is it that I used to be so reluctant to add to winners, because I’m buying shares higher than I bought them initially?

In hindsight this thinking is ludicrous to me.

I can appreciate getting good prices on the stock of a company because of short-term fluctuations in the share price due to one-time news events, or on a market wide pullback…

Now…. my mindset makes me wonder why it’s ever wise to add on big drops after a substandard earnings report. Sure, it might be temporary in nature and if I have a long-term view of a company it could recover.

I’m just not sure my crystal ball is that good.

Some days I wish I didn’t see stock prices, but only got to review news and financials in order to really make decisions on my subsequent stock purchases (an experiment perhaps??)

We get very caught up in the $ value of a company’s shares, and we get very lazy about reviewing how the company is actually doing, because the market “tells us” what to think about the company given its share price.

just my 3 cents……

Cheers
Nick

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But what happened???

Did the company go out of business?

Did the new marketing plan ever go into effect?

What would you estimate you investment is worth now?

Come on, Nick! Don’t leave us hanging!!

Jeb

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As I read it, what happened is that he lent them more money, and now is (a) waiting to see how the business does, and (b) having second thoughts.

I hope there is a stock repurchase agreement that mandates the company to buy back shares upon request since there is no public market for the shares. Also how frequently does the company have an independent auditor provide their best guess on the value of the shares in case of a repurchase?

Thank you for the responses -

I should have summed up a little better (math major, not english- hah)

This is an “add to your winners” story. I’m trying to capture my thoughts here in order to apply them to how I invest in public companies.

The business is doing really well, and this process is happening right this second (which is why I’m not talking in more detail)

The new marketing blitz, rollout of other business initiatives… that all started a few months ago. That’s when the business started its uptick. The talk of the partner buyout sparked a really deep dive back into the financials of the company (and yes, independent audits/valuation estimates).

When seeing the business uptick, especially the increased recurring revenue and average revenue per customer all go up, I pulled the trigger offered more cash for more equity in the company to help speed the payout of the departing partner.

The lesson I learned is that I had no second thoughts about “adding to my position” when I carefully reviewed the financials and saw the business was doing better. There is no share price, but if this were a public company the news would have probably driven the share price up. I dont know - just guessing.

So I’m trying to force myself into this thinking for the public companies that I own shares of.
If this were a public company and, suppose the share price spiked on the news of the increased revenue, why wouldn’t I add to my position there too?

Instead, I used to get lured into adding shares of a company when the stock price got hit after say, a poor quarter. That’s the thinking that is ludicrous to me…

So since 2014 the overall valuation has roughly quadrupled (woot!), and the additional share purchase plus the partner buyout will boost my stake by around 7%.

cheers
Nick

PS - soccerboy - yes. we have a share repurchase agreement written into the partner contracts.

10 Likes

maybe not your main point but you did get a very good deal initially. 10% interest on a 3 year loan and 15% equity. I don’t know anything about private investments but that sounds just great.

How did you get that deal?

tj