Two years ago, I invested a large sum of money into a private equity deal to take over a family-run home doctor service. The deal was with a group of respected players, and the new money was designed to expand the business model across the country.
CEO and board dysfunction prove damaging
The investment appeared to promise a potential 500% return over three years. Two years later, it was looking as though we would be lucky to recoup any of our capital. The company had a dysfunctional board that lacked diversity and was very confrontational. There was also a bad decision made over the choice of chief executive. This CEO had invested in the business but worked part-time and blamed everyone else for his failings.
Poor marketing, resourcing, and grasp of legal landscape
Moreover, there was no clear marketing strategy or resourcing, which had an impact on sales. The final straw was the company’s failure to anticipate regulatory changes driven by an attack on the company’s after-hours business model by the day clinic/general practitioner political lobby group.
It was all very sad but with it came a big lesson. To avoid failure in the early stages of starting a business, make sure to put the basics in place.
Andrew’s takeaways – Avoid these mistakes to become a better investor
Putting money in is not the problem, it’s getting it out that can be trouble
Investing in unlisted private companies poses a unique challenge because it is very difficult to exit when you are no longer satisfied with management.
A minority stake in a company means when it comes to the crunch, you have no voice
Another risk in owning a minority stake in any company is that, as a minority, you do not influence the way the business is run. When you are an employee, there are times when management will offer for you to earn shares in the company instead of pay. My advice is generally to avoid such an offer. This is because you will have no control over the management of the company, you will have deferred your compensation, and, if things go wrong, there may not be a buyer for your shares.
In this story, the investor suffered because they had no control over the board or the management. An exception to my advice on not owning shares is if an established company offers additional compensation through shares as an incentive program; particularly when the company sells those shares to employees at a discount. But in such a case, be careful of building up too much of your wealth in one investment; if things go wrong with your company you could lose your job and your wealth, a double whammy!
Ability to depend on the expertise of a company’s leaders is crucial
Another risk to consider is that of the changeover of management. This was risk arose in this case when new management took over a family-run business. In such cases, investors expose themselves to the risk that the new management is unable to make the business successful. The lesson is to stick to proven management if possible.
Avoid investing in people you just don’t know
Another danger in this story is the risk of investing in people you don’t know, the new management. Be very careful in situations in which you are investing in people you don’t know. If you insist on doing it, make sure to do your research on the peoples’ past decisions and relationships.
Mistakes in this story
1. Failed to do their own research
- Lacked knowledge of regulations
- Let things get too complicated
2. Failed to properly assess and manage risk
- Bought an illiquid investment
- Lacked influence over management
4. Misplaced trust
- Failed to review a person’s history and references
- Were overconfident in an unproven management team
Learn about the six ways you will lose your money and how to avoid them here.