Most small businesses need investment at some point in their lifespans. Some businesses may require an investment to start initial operations while others may need funds to grow or to weather unforeseen circumstances. If you’re looking to invest in a business, here are some general investment tips and how to navigate your first small business investment.
Types of investments
There are two common types of investments in existing businesses:
- Equity investment: An equity investment involves an investor buying a portion of a business. By owning a share in the business, the investor is entitled to a portion of the entity’s earnings and dividends. An investor is rewarded based on how well the business does over time.
- Debt investment: Debt financing involves an investor lending capital to a business. The business owner will typically repay the loan amount with interest over the agreed-upon loan term. This type of investment requires a repayment obligation that is not tied to a business’s revenue. Debt financing can be risky for small or new businesses.
[Read more: Private Equity vs. Venture Capital: What’s the Difference?]
Tips for investing in a business
Investing in a business can be a rewarding enterprise but it requires a certain amount of knowledge and forethought. Here are some general tips on investing.
Search for deals
The best sources of investment opportunities are in your established network — friends, family, and business contacts. Consider searching for startups, local businesses, and entrepreneurs on social media to broaden your network.
Not every business is searching for investors, however. Some businesses are overextended or not willing to relinquish portions of the business in exchange for capital. Don’t burn network connections while searching for the perfect investment opportunity, and be wary of too-good-to-be-true investment opportunities.
It might be tempting to sit back and watch the investment returns roll into your bank account, but you should stay involved throughout the process.
Conduct due diligence
After you’ve conducted a thorough search and have found the perfect investment opportunity, conduct due diligence so you get a better feel for the company and its operations. Meet with the company’s leadership team so you can learn about the company’s goals and how its leaders plan to use the investment. This will help you feel more involved before committing to an investment.
Next, gather information about the company, including its financial viability and business model. Run background and credit checks on the company’s leadership to determine any risks associated with a potential investment.
Consider hard data and numbers
Examine the data you’ve collected on investment opportunities and boil it down to cold hard facts. Every company tries to prop itself up as a unique idea, but do the numbers reflect that? Does the company have a solid track record of meeting goals? Does the business plan use data-based financial projections? Your money deserves to go to a company that has hard data and numbers to support its lofty claims.
Negotiate terms
Hammer out the investment agreement by negotiating terms that work best for both parties. The outline of your term sheet will depend on the type of investment. For equity investments, a term sheet will outline the percentage of the ownership of the company, the percentage of profit return, and the investment amount. For debt investments, a term sheet will include the loan amount, the loan term, and the repayment process. Once the term sheet is completed, present your terms to the company’s principals during an investment meeting.
Your initial term sheet might not be accepted word-for-word. Be patient while negotiating your term sheet with the company — these are your future business partners.
[Read more: Looking for an Investor? 3 Types of Investment Deals for Small Businesses]
Seal the deal (and stay involved)
Once your term sheet has been accepted, the final step is to close the deal. Both parties will sign the agreements, and the company will receive capital.
It might be tempting to sit back and watch the investment returns roll into your bank account, but you should stay involved throughout the process. The economy and business operations change faster than you might think, so keep a finger on the pulse of any investments you have in the market — you might just find your next investment opportunity!
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.
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