The SBA (Small Business Administration) has found that around 500,000 new businesses are launched in United States yearly. Since there might be problems to avail financing, these startup entrepreneurs frequently seek the help of acquaintances, family or friends for funding. However, in case you get such an opportunity for investment in a startup business, you must be careful.
Consider liability, the business valuation, your timeline as well as the exit strategy. Prior to thinking of a partnership or taking the stride, go through these basics.
Be careful regarding the opportunity
It is generally hard for ordinary Americans to come across a private business for investment. If you are not in touch with the business community or are not an acclaimed local business player, there is high probability that you will not find any opportunity. A majority of opportunities for investing in startups come from family, friends or word of mouth, and once you get such an opportunity, you must ask yourself the reason why it has come your way. It is most likely that the business needed money and could not obtain it from a bank. So, you must find out the inside story.
Comprehend the structure
It is important for potential investors to meticulously comprehend the business structure. Thus would determine how the legal system and IRS view profits and liabilities. There is high probability that the business could end up in failure, a fact backed by the SBA which has reported that around half of the small businesses fail within 5 years of starting. On the basis of the business structure, you could be responsible for liabilities or unpaid bills in case of a failure. Hence it is very essential to draft official documents and record everything in written form, even if the business is owned by a close family member or friend.
Returns may not come for years
Even if you invest in a small business that remains afloat and generates profit, those profits may not reach your way for years. So, in case you are looking at a specific time frame to avail returns on capital, the best option is to invest through a loan. However, if you make an official loan to the startup at an interest rate regulated by the market and with a fixed term, you will get a steady income source as well as a guaranteed return on the principal.
Formulate the exit strategy
Once investment is made in an untested startup, it is most likely that your money is tied up for some time. Withdrawal of initial investment is also hard even if the startup succeeds and you start receiving dividends. Minimum 5 years time is needed for accessing certain cash flow or capital. Keeping all this in mind, formulation of an exit strategy is important. In other words, you must have a plan for selling off the stake in case it is necessary.
Do your homework properly
It is advisable to know the background of those who are a part of the management. You should also have some understanding regarding the industry in general, including the competition. You must ask for a complete business plan that fully contains the business description, financial plan, marketing strategy, as well as a SWOT analysis.
