How to Find Fortune In “Little-Known” Companies

Written by Jason Simpkins
Posted November 4, 2016

How many times have you heard about a millionaire or billionaire who struck it big on a “little-known company” that turned into a mega-giant?

Take Google, for example.

Everyone knows that if you invested any significant amount of money in the search giant when it went public in 2004, you’d probably be a millionaire by now.

But what about the people who invested in Google back in 1998? They made even more money, and they made it a hell of a lot sooner.

Amazon’s Jeff Bezos was one of those investors. He plunked down $250,000 in 1998. Andy Bechtolsheim (founder of Sun Microsystems) also made a six-figure investment in August of that year. There were other, lesser-known names too: Ram Shriram, Ron Conway, David Cheriton.

They all made billions off their investments.

Here’s another example: David Choe.

Choe was a graffiti artist with a criminal record when a little-known company called Facebook paid him to paint the walls of its first office. But instead of getting paid in cold, hard cash, Choe accepted private shares of the company. This was in 2005, mind you, a full seven years before the social media pioneer went public.

Choe is now personally worth more than $200 million. Not bad for a little interior decorating.

You don’t necessarily have to get in pre-IPO, either.

Sure it helps, but it’s not a prerequisite.

You can get private shares of a “little-known company” through a private placement deal.

You see, big companies can always borrow money from major banks, or simply issue more public shares onto the market. But a small company may not yet have the credit or assets to leverage a big loan. And by issuing a private placement, as opposed to public, they can avoid fees and be exempt from having to file a prospectus.

That makes things a little riskier for investors, of course, but isn’t that always the case with a little-known company?

The trade-off is that private placement investors are often compensated for that risk. In addition to higher potential returns, investors can also be issued shares at a lower price than what’s on the public market. They could also be given a warrant (a half-warrant or a full warrant) that allows them to buy more shares at a future date.

As a result, private placements, like pre-IPO deals, are often preferable to buying shares on the open market.

So, how can you recognize these deals? What should you look for? How can you profit?

I’ll tell you...

Pre-IPO vs. Private Placement

First off, investing in a company pre-IPO is hard.

You can thank Congress for that.

A piece of legislation called the “Accredited Investor Rule” was enacted after the 1929 stock market crash.

Ostensibly, the law is meant to protect the average investor by limiting their exposure to the most speculative growth opportunities there are: Early-stage, non-public companies.

But in reality, it's just another way for the wealthy and well connected to multiply their fortunes while shutting out the little guy.

This rule, which is defined in Rule 501 of Regulation D of the Securities Act 1933 says that you are NOT eligible to take part in non-public equity investing unless:

1.) You have a liquid net worth of more than $1 million — excluding real estate; or

2.) You have earned in excess of $200,000 for the last two income tax years (as an individual), or $300,000 (with a spouse).

Of course, there is one notable exception to this “law.”

That’s the 'friends and family' exception, which allows you to invest in a venture started by somebody close to you. (That's the loophole David Choe was able to exploit.)

Still, if you’re not neighbors or roommates with the next Steve Jobs or Mark Zuckerberg, you’re pretty much out of luck.

Now, getting into a private placement is much easier, but it’s still not for everyone.

There’s no minimum to invest, though no company is going to be interested if you’re just offering peanuts.

That’s because this can often be an extensive process for both you and the company. Investors need to fill out subscription documents that are sometimes 30 or 40 pages in length. They have to parlay with a broker who in turn will have to parlay with the transfer agent.

So, if you’re going to go this route, you really want to make sure that the amount of capital involved is worth everybody's time, including your own.

If it is, then you can find a private placement pretty easily. These companies are looking to raise capital and any company raising money has to file with the SEC so the information is public. You can sift through filings and know on a daily basis when a new private placement becomes open… if you have the time and patience, that is.

If you don’t, that’s okay, too, because we recently started a service that does all of this legwork for you.

The service is called Nick’s Notebook, and it’s run by veteran investor Nick Hodge.

Over the past year, Nick has recommended 23 private placements, with members collectively contributing $50,000 to $1,000,000.

Eighteen of those have been winners so far, with closed gains including 1,480%, 660%, and 531%.

Of those that remain open, only five are down, while seven are up triple digits, including 156%, 176%, 218%, 259%, and 277%.

So his track record is outstanding.

The fact that Nick finds and vets all of these companies will save any serious investor hours, if not days, of work. So it’s definitely worth it if you’ve got the inclination.

Still, if you want to go it alone, that’s fine too. We always encourage independence at the Outsider Club. So feel free to press on without our help.

If you do, keep the following tips in mind…

Careful Considerations

Evaluate a company’s management team and plan: If you’re plunking down big money in a private placement, you should have access to executives. Don’t be afraid to grill them on every aspect of their business. And try to invest in pre-vetted startups

Carefully consider a company’s market potential: Invest in what you understand. Is there really a market for its product? How healthy is the industry as a whole? Are there barriers to competition or is competition a barrier to success?

Monetization: How long before this company becomes profitable?

“Spray & Pray”: Take a diversified approach by investing in multiple companies that you’re confident in. You’ll have some failures, but one home run is all it takes. And remember to reserve capital for follow-on rounds.

That’s all the help I can offer you at this point. But again, if you’d like some more in-depth analysis and an experienced hand, you should sign up for Nick’s Notebook.

I know these kinds of investments can sound daunting to the average investor, but the potential rewards are well worth it. They exceed anything you stand to gain from the public market.

Fight on,

Jason Simpkins Signature

Jason Simpkins

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Jason Simpkins is Assistant Managing Editor of the Outsider Club and Investment Director of The Wealth Warrior, a financial advisory focused on security companies and defense contractors. For more on Jason, check out his editor's page. 

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