There may be times when your business needs an influx of money. Perhaps demand for your services is growing so fast you can hardly keep up. Maybe you even want to move your restaurant to a more centralized location to attract more customers.
In order to expand your business, you’re going to need cash—and in some cases, a lot of it. And cash is something that most small businesses manage carefully—certainly not something they discuss openly with strangers. However, even if you’re uncertain about bringing outsiders into the picture, the day may come when you’ll decide to seek investors in your small business to fund growth or pump up your cash reserves.
An investor is different from someone who merely lends you money. While a business loan is mostly hands-off as long as you make your monthly payments on time, investors are more deeply involved in the inner workings of your small business. They share in the high times if your business is profitable and the lows if everything goes south. By buying a specified stake in your business (ranging anywhere from 1% to 99%), they gain partial ownership. And they have a much closer relationship with your business than a bank simply providing a loan.
What types of investors are interested in small businesses?
There are three different types of investors in small business you should be aware of if you’re looking to expand. For businesses with less than 20 employees, the most common ones are:
- Personal investors
- Angel investors
- Venture capitalists (VCs)
These are all equity investors, which means they receive a share of the company in return for providing funds. The more money they invest, the bigger the share.
Here’s a description of each of these types of investors.
Many investors in small business are friends or family members of the owner. This makes them personal investors, also known as “private investors.” Although they can be a big help when you need quick cash, they generally can’t afford to invest very large amounts of money long-term. Also, there are some drawbacks that go hand-in-hand with asking a loved one to invest (more on that later).
An angel investor is someone with a high net worth who has enough expertise in your industry or market to make your small business a smashing success. These individuals can usually invest quite large sums—in some cases, even so much you don’t need any other investors.
However, they’re usually very picky about where they put their money, and they expect a higher-than-market-average return. They also expect to have a say in the day-to-day running of the business. If you’re interested in going down this route, the Angel Capital Association lists angel investors by state.
A venture capitalist (VC) offers money to small businesses with long-term, high-growth potential. Unlike angel investors, who use their own money, VCs use the funds of others who invested in the VCs’ funds.
VCs may or may not have domain expertise in your business area. They act similarly to consultants, rather than taking on the more hands-on, operational role of an angel investor. VCs can offer you access to the greatest amount of capital. But their financial agreements tend to be more strict than personal or angel investors. They’re also faster to pull the plug on their investments if things aren’t going well, as they have their own investors to answer to.
Best practices for taking on investors
Although finding an investor willing to put money into your business is often difficult, that doesn’t mean you should take the first one who comes along. Research your potential investor(s) carefully and follow the best practices below to protect yourself from making a decision you’ll regret.
Be protective of your personal relationships
Although personal investors are often the easiest to find, be aware more than money is at stake when you choose to go down this road. If you go the “personal investor” route and involve your friends and family in your business, remember many friendships and relationships have ended over money. As a small business owner, it’s natural to feel optimistic about the future of your venture. But be sure to realistically present the potential returns versus the risks of investing in your business if you want to keep your relationships.
Understand what investors want from you, and be crystal clear about your terms
Some investors may want long-term income and profit sharing. Others aim to grow their equity or simply to increase the number of shares they own and get out.
Remember that investors are formally purchasing part of your business, so involve a lawyer and do everything correctly. Make sure to use clear language about percentages of equity, number of shares, and anything else your lawyer advises. Lay out a plan detailing exactly what happens if you solicit future investors. The more direct and transparent you are upfront, the fewer problems you’ll have later.
Don’t give away more than 49% of your business
If you intend to maintain control over your business and have the final say about important financial decisions, make sure to hold onto at least 51% of the shares. Your investor(s) are going to have their own ideas about how to run things, and you might not always agree. If you sell them more than 49% of your business, you might not have a choice. After all, they aren’t loaning you money, but rather purchasing a portion of your company as a whole. By maintaining more than 50% of the shares, you’ll always have the final say in both trivial and important matters.
Choose investors you like and respect
Once investors buy a share of your business, they become your partners. They can—and most likely will—look over your shoulder as you make decisions about your business. Before you accept their money, gain a clear picture of their vision for your business. Discuss what direction they intend to go, or what new business models or markets they might want to pursue. Even more importantly, make sure you like them. You’re going to build an ongoing rapport with them, so try to choose investors you can see yourself getting along with long-term.
Identify investors’ exit strategies
One of the most important questions you can ask potential investors is, how and when will they want to exit your business? Few investors want to keep their money tied up with you for the rest of their lives. Although they’re offering you cash based on the promise of a future return—a return they’re willing to wait for—make sure you have a very clear understanding about when they might want their money back so you aren’t caught off guard by a sudden departure.
The perfect investor is out there somewhere
The key to finding an equity investor who will help your business thrive is creating a robust business plan that showcases high long-term growth. All reputable investors calculate return on investment (ROI) carefully, which means they’re most interested in:
- Reliable cash flow
- Products that meet market needs
- Tight managerial control of expenses
If you’ve managed to cover all these very important bases with your small business, there’s a good chance that with some hard work and research, you may catch the eye of your dream investor someday soon!