What are the advantages and disadvantages of raising money from private investors?

A private investor is a person or company that invests in a business venture in exchange for a percentage of the company’s profits.

Author: Brad Nakase, Attorney

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When Is It Good to Have a Private Investor?

Access to business capital is important for every company, whether it is an existing business or a startup in its first stages of growth. The Small Business Administration reports that the typical entrepreneur requires $10,000 to open a small business. Also, if a business owner intends to hire employees, then he or she will need additional funding for payroll.

A major part of a business plan involves how a business owner means to fund operations. While it is common for small business owners to utilize a combination of loans and self-funding, there is also the option of looking for venture capital from outside investors. That said, similar to other funding options, there are downsides to investor funding. However, the benefits of investor funding could also truly launch a business. The following list of pros and cons will help a business owner consider whether finding investors is the right move for his or her business.

  1. It Is Not a Loan

Business loans can be great financing options for many companies, but a business owner will need to repay it whether the business succeeds or fails. Outside investors, meanwhile, accept the risk that comes with investing in the company. So, if the business fails, then they simply lose their money. This means that if the investment does not work out, the business owner is not responsible for repayment.

But it is important not to mix up investors and private investor loans. The second is a type of financing, also called private lending, that happens when individuals offer funds to investors in order to receive a loan with private real estate. This is an alternative to bank loans and other traditional loan sources.

  1. No Need to Provide Credit History

Business lenders can have strict requirements when it comes to credit and financial history requirements. This can make the loan application process difficult, and there is no guarantee that one will be approved. By contrast, private investors are usually more interested in the money the business owner can earn them down the road, rather than what the owner has done in the past. Because of this, they are generally more likely to accept risk than traditional loan providers.

  1. Provides Access to Investors’ Expertise

Plenty of business investors have a lot of experience with running companies. In fact, they may useful knowledge about one’s industry. This means that they can offer a business owner insight that he or she otherwise may not have gained.

After a business owner identifies legitimate investors, then he or she can use their expertise to improve the chances of their company succeeding. According to a Harvard Business School study, new companies backed by investors had much better results than startups that did not have this kind of funding or support.

  1. Reduces an Owner’s Share of Earnings

When an investor offers money to a business owner, he or she expects a share of the profits. This means that if the business becomes wildly successful, the business owner will not make as much money. Sharing equity in his or her business will not prevent a business owner from becoming successful, of course, but they should be conscious of giving away too much equity.

  1. Higher Stakes

The bottom line is that investors are interested in making a profit. Because they are taking a risk, they expect a business owner to meet certain performance expectations. Thus, there can be a lot of pressure.

Before a business owner agrees to accept investments from outside individuals, he or she should be sure that the investors’ expectations fit his or her capabilities. If these goals do not match, then it is best to look elsewhere for financing.

  1. The Owner May Lose Some Control

The majority of outside investments come with caveats. When there are additional stakeholders in a business, then the owner must answer to more people than just themselves. The investors may want to be an active part of the decision-making process, or they may want to approve an owner’s actions.

Certainly, a business owner will be expected to explain their decisions. A business owner will therefore need to be comfortable sharing control of his or her company.

How to Find Investors for a Small Business

Social Media

Social media is where many entrepreneurs look for potential investors. But it is important to do research so that one does not fall prey to online scams.

Family and Friends

Sometimes, a business owner may have family or friends who are interested in investing in the growing company. While it can be nice to have an established relationship with an investor, complications can arise. Working with a loved one may create tension, especially if the business falters or fails.

Crowdfunding Platforms

There are a number of online platforms where small business owners can get in touch with investors interested in their projects.

Conclusion

Twenty-nine percent of small businesses fail due to a lack of cash flow. While it may be tempting for a business owner to grasp at any funding opportunity that comes their way, it is important to weigh the pros and cons of every option prior to going forward.

If a business owner does not want to give up a portion of their business’ profit or have others question their decisions, then outside investors are probably not the right move for their business. However, if a business owner looks forward to benefiting from an investor’s expertise, as well as their financial contribution, then it may be the perfect funding solution.

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