Perhaps you are not familiar but more than 500,000 new businesses are started every single year all over the United States – according to the Small Business Administration. Since finance can be difficult to obtain, SMEs (small business entrepreneurs) often make their way towards their nearest and dearest or acquaintances for financing. If you have the chance to invest in a company startup, you can go but carefully. Think twice about the liability, your corporate valuation, your schedule, and your exit strategies. We have compiled some basic elements to be learned before investing, taking a partnership or jumping into a new business.
Be Careful of the Opportunity
Normally, finding out a way of investing money in the business is hard for ordinary people. It is unlikely that you will be approached with an opportunity without being a well-known local business player. Most investment opportunities for small businesses are provided by friends, family or word of mouth. It might be a relative who wants to open a restaurant or a friend to turn his brilliant idea into a business. While a red flag could be thrown, it does not necessarily indicate that an entrepreneur or a startup is unable to receive funding. However, startups nowadays have difficulty getting funding. Even a business with sustainability for numerous years can face a problem if the bank doesn’t take a risk.
Get to Know about Business Structure
Being a potential investor, you should understand the business’ overall structure very well with care. You can determine the liabilities and profits of the IRS and of the legal system. It is possible that business could fail — approximately 50 percent of small businesses close in the first five years, according to the Small Business Administration.
If the company fails, you may be responsible for unpaid bills or liability in person. However, it entirely depends on the structure of the company. Investors should consider limiting their liability and recommend that they stick with a limited liability company or LLC. An LLC’s major characteristic is that its owners are not generally liable for the debts of a company. It is frequently wrong to invest with a little more than a handshake in the company of a relative. Regardless of how close you are to your relationship, you should draft official documents and write things down.
You Won’t See Returns for Years
It could take many years before any of these profits come to your way if you want to make your mind for investment in a start-up that will remain afloat and profit. If an investor has a targeted period of return on equity and a profit that he/she wants to earn, he/she should consider investing instead via a loan. Putting a large amount into a trust-based business, and then hope for dividends later has no guarantee.
But an official loan for the entrepreneur or start-up can provide the investor with a steady stream of income and a more guaranteed return on capital at a market-based rate with a fixed term. Please note that loans are not repayable in most of the cases. Therefore, you must make it official with proper documentation. Also, legal paperwork if you really want to get your money back.
Plan Properly for Exit Strategy
You could be tying your money up for a while when investing in an untested company. A new company could burn your entire investment before it opened its doors. And would then need years to earn a solid income. Yet it may be difficult to withdraw your initial investment even if your company is successful and you start getting dividends. A person should be willing to wait at least five years before he or she has any access or some kind of cash flow to such capital.
You should discuss the type of “exit strategy” and one way to liquidate the investment. Regardless of whether your time is set or your return, you should develop a proper plan to sell off your stake in the firm. You cannot sell your stock in a private company with a mouse click unlike a public enterprise trading on the open market.
Don’t Forget to Do Your Homework
You should be well-aware about the background of every single involved in the management of the business you are going to invest in. Moreover, you should have a well understanding of the business as well as competition. You must request for complete written business design, including business description, marketing plan, financial plan, market analysis. Also, request for a SWOT analysis (powers, weaknesses, possibilities, and threats). Entrepreneurs often have great visions of their business, but they do not really plan to implement them.
If a startup has a business plan, then there is “very little to go on.” You should use Detail attention, professionalism, and presentation of its plan as an example of how they can function when in business. You should analyze the forecasts or representations in the business plan carefully and use external sources to vet them.