Understanding risk vs. return when investing in private companies

Last week, we received a question from a reader that I felt was a good topic for a blog post for a couple of reasons: it is timely, and it gives me an opportunity to discuss how we handle comments.

I’ll start with our comment policy first, and then I’ll deal with why the question is a good topic to discuss at this time of year.

We could not publish the comment, because it asked whether an investment in a particular company was “safe”. We do not give investment advice, nor do we discuss the viability of investment products. For obvious reasons, we do not publish the names of companies in this context.

The person asked us if a promised 10% return in a private real estate investment is safe?

The simple answer is no. If you invest, you are taking on some kind of risk no matter the investment. On this blog and in our seminars, we always tell people that the higher the return an investment offers, the higher the risk. Today 10% is a high return on an investment. These days, many interest-bearing GICs, which are low-risk investments, are offering about 2%.

To this answer particular comment, we would add that investing in private companies – real estate or otherwise – can be a high-risk proposition.

We recently published the InvestRight Guide to Investing: the private placement market for retail investors. This Guide talks about how the private placement market differs from the public capital markets (equity exchanges, bond markets, etc.). It also explains how the private placement market works, and it sets out the risks of business failure and the risk of fraud in this marketplace. It is essential reading for any retail investor looking at investing in a private company.

The question is timely because it is RRSP season.

Investors may come across private real estate funds that are RRSP eligible in their research. Just because an investment qualifies for an RRSP, does not mean you should (or can) purchase it. There are rules companies must follow when offering private placements to retail investors. You will find these rules explained in the Guide. Furthermore, a fund must apply to Canada Revenue Agency and obtain a letter stating it is RRSP eligible. Before investing, ask the fund to provide you with a copy of the letter.