| Golden rules |
- Resist the temptation to invest straight away.
- Look for a clear picture of the business and how it will make money.
- Decide if the risk suits you.
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| New ventures may be riskier | New ventures include:
- branching out from the regular business into a new industry
- combining newly purchased businesses
- using new technology, new products or new inventions
- forming a new company from scratch.
These may sound exciting but are often riskier or harder to value because the company or business won't have a track record. |
| Look at the business risks | All businesses take risks, but the risks increase when businesses:
- rely heavily on good market conditions
- operate in markets where it's either 'a feast or a famine'
- start up competing with well established, profitable companies
- stake the company's fortune in finding natural resources, or commercial breakthroughs in science or technology
- burn up cash and often need extra money
- depend on favourable government decisions
- are just too complicated and hard to understand.
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| Scrutinise forecasts and projections - they look at an uncertain future | A forecast is an estimate based on future events or actions which management reasonably expects to happen or carry out, at the time the information is prepared. (But things often turn out differently.)
Forecasts are usual but not required. If you find one, it must state all the underlying assuptions on which the forceast is based. Look at those assumptions. If you do not agree with any one of them, you are not likely to agree with the forecasts.
Forecasts will be less reliable if they:
- look a long way into the future, sometimes more than 2 years
- assume only good results
- skimp on explanations about what the directors are assuming
- don't disclose the likelihood of the assumptions actually occurring
- don't explain the effect of a variation in the assumptions on the forecast
- don't say what happens if investors put in less money than the prospectus sought.
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| What's the company worth? | You would expect to see details of profits and losses, a company balance sheet explaining its assets and liabilities (that is, its financial performance and position).
Accounts for companies are less reliable if they:
- use old information
- show a high percentage of the company's assets as intangibles (brands, patents, goodwill, intellectual property)
- value assets at the top end of the range.
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| What are the directors getting out of it? | The prospectus must fully explain if any directors will make money or receive a benefit in connection with the issue.
An offer is generally more risky if it:
- offloads most of the directors' original stake in the company to you without adequate explanation (Do they think selling to you is better than holding on?)
- gives vague or skimpy details about deals with directors
- offesr no independent valuation of assets directors may be selling into the business
- puts a price that looks high on assets that directors may be selling into the business.
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| How risky is the offer? | The more risky offers may:
- raise large amounts of new capital compared with the company's size
- rely on raising more than the minimum amount to cover what the company wants to do
- skimp on describing what the company will do with the money
- lack an underwriter to pick up any shortfall if not enough money is raised, or use an underwriter without an established reputation.
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| Study the fine print - the offer's terms and conditions | Once you've decided you're interested, read the details of the offer.
- some securities don't operate like ordinary shares and may prove harder to sell later
- get a stockbroker or licensed adviser to explain complex terms and conditions.
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