Private investors often get burned at the stake.

• Author: Martin, Ed
• Position: Risk of investing in private companies

It sounds like an investor's dream. "We started with $3 million from 30 friends, family and associates. They cashed out with a 1,000% return in three years. I put in $20,000 and made back $40 million." So says Mike Feuer of Cleveland, Ohio. In 1988 he founded OfficeMax, an office-supply chain with two stores each in Raleigh and Charlotte and one in Fayetteville. In 1991 he sold 90% of the company, which projects 1993 sales of $1 billion, to Kmart.

It's figures such as Feuer's that get would-be investors reaching for their checkbooks, ready to take a flyer on a young private company.

But the realities often cause investors to thud to earth in a hurry. Joan Zimmerman, president of Charlotte's Southern Shows Co., had a very different experience when she invested in Lake Norman Co., a real-estate development company based in Charlotte. "We went in starry-eyed. Land around the lake seemed like a very good investment," she says. The company reorganized under Chapter 11 in 1990, and now Zimmerman sadly summarizes the downside of investing outside of traditional stocks and bonds. "I lost $126,000. No return. No interest. No dividends. No tax advantages."

Unfortunately, investors' experiences are more likely to parallel Zimmerman's than Feuer's. To start with, investors in private companies are unprotected by disclosure mandates or trading regulations from the Securities and Exchange Commission or the stock exchanges.

Furthermore, investments in private companies often pay little or no ongoing returns. You may make money only when you sell, if you can sell. Private stakes tend to be illiquid, with no publicly quoted prices or ready buyers. Charlotte-based Robert McNairy, senior partner in McGladrey & Pullen, a CPA firm that specializes in private companies, warns the unwary: "There's no market for your stock and no dividends. It's not dangerous or risky -- it's just plain foolish. Save time. Flush your money down the commode."

According to Don Hays, manager of investment strategy at Wheat First Securities in Richmond, plum deals are generally offered to institutions and large investors but only rarely to small investors with portfolios of less than $100,000. "Good deals usually go to those with huge amounts of money they're willing to risk," he says.

Ed Crawford of Atlantic Venture Co. of Winston Salem, which manages $35 million in venture capital, agrees: "Most who invest in private issues have a high net worth. They're doctors, lawyers and so...