The Small Business Association estimates that about 500,000 new businesses are launched annually in the US. About 50% of these close within the first five years of operation due to a variety of reasons, key among them being a lack of adequate funding.
Most startups find it hard to get the funding they need to launch their businesses and have to rely on their savings. Alternatively, some opt to raise money from their families, friends, and acquaintances. While some do manage to get their business off the ground, they often lack the funds to remain in operation and end up folding. There exists a real gap that savvy individuals can take advantage of by investing in such businesses.
Investing in small businesses and startups can be a great experience from which all parties involved can benefit. One obvious advantage is that the owners get the funding they need, but how can investors benefit? Well, investors who put their money in startups are eventually helping to build the economy. Small businesses are crucial avenues for job opportunities, and some even have worthy ideas that are capable of changing their industries. Those who invest in them are helping these ideas to come to light.
Furthermore, financing a startup can give an investor the chance to take on a more hands-on role in directing the company, if they so wish. Depending on their expertise, they can assist a company to grow from a fledgling business to a fully grown entity that realizes handsome profits at the close of every financial year.
However, this is also a risky investment option, with inherent challenges. Investors who wish to diversify their portfolios to include small business investments should consider working with a dedicated investments advisor. Ken Fisher, founder and CEO of Fisher Investments, has built a solid reputation as one of the best investment advisors in the business. When choosing an investment advisor, the investor should look how the advisor invests for their clients, and then choose the advisor that fits best.
Just like other investments, putting money into small companies can be a risky venture. The company might fold or it might bleed resources with nothing to show for it. These are just some of the aspects that individuals need to consider before financing startups. Others are outlined below.
The opportunity on offer
Potential investors need to seriously consider the opportunity that is on offer. What does the small business deal in, and what is the story behind it? Who are the owners, and do they have the passion, perseverance, and experience needed to run a business? Investors must also consider how much money they are willing to finance and how it will be used. It is also advisable to have an idea of the industry the business is involved in as well as the competitors it is up against. This calls for adequate market research prior to signing the deal.
The business structure
Another thing to take into consideration is the business model itself. Investors need to have a good understanding of how the business is structured as well as the party responsible for liabilities in case of business failure. Most investors opt to stick with limited liability corporations (LLC), where the owners are not liable for any company debts should the business go under; their investments are protected.
The potential returns
Every investor puts their money into ventures with the hope that they will prove profitable in the long run. However, small businesses are quite risky and require owners to plow nearly all the earnings back into the company for the first couple of years. This is normal, and individuals should be aware that their investments might not bear fruit for quite a few years. A good way to get around this is by making the investment in the form of a loan. The business owner has to pay back the loan at market rates, giving the investor a steady stream of income and better protection of the principal investment.
The exit strategy
Investors also need to consider their exit strategy in case their investments do not match their expectations. It is a good idea to have a legal document in place outlining details of the agreement prior to making an investment. This helps to keep the exit strategy relatively hassle-free.
Investors who are interested in financing small businesses or startups should first weigh the pros and cons before making their decisions. Although risky, their investments can pay off in the long term as long as they do their research right from the beginning.