If you’re thinking of starting a small business or you’re currently in the startup phase, one of the most difficult challenges can be finding capital, especially from a bank. For new businesses, proper funding can be the difference between success and failure. A new company often needs backing to pay for things like equipment, employees, insurance, office space, and a host of other things.
In uncertain times, such as during the COVID-19 pandemic, it can be hard to get money from big lenders. In October 2020, business loan approval rates dropped to 13.3%. Even if you do manage to secure a loan, you have to pay that money back. The bank doesn’t assume any risk.
Don’t be discouraged, though. Many forms of financial assistance exist, and one of them is through finding personal investors. Personal investors provide business funding, usually in exchange for a percentage of ownership. Because personal investors have a stake in your business, it matters to them that you do well. But what are your options for choosing the right private investor for your business?
Below, we’ll help you navigate the world of private investors so that you can secure the money needed to get your small business on the right track.
Whereas a bank loans you money, private investors become part of your team. This can be great when you’re just starting. Your personal investor will help you make the right business decisions to grow your company.
Some investors might even specialize in your industry. Many private investors want to make sure they’re knowledgeable about the industries they put money toward. Someone with the know-how in your field can be a great asset. For example, if you’re a freelance writer starting a limited liability company (LLC), an investor specializing in your field can guide you toward higher-paying clients.
There’s also less risk involved in getting a private investor than a bank loan. Imagine having finally opened a food truck right when the COVID-19 pandemic happened. You watch as people eat out less, and your business loses valuable funds. With a bank loan, you’d still have to pay the money back with interest. With personal investors, everyone would lose their initial investments, but you wouldn’t be on the hook to pay the money back.
If a private investor chooses to sponsor your business, it’s because they believe in it. Having that kind of support can help you stay strong during the tough, early stages of building your business. On the other hand, banks decide whether to give you money based on your credit history. Private investors will want you to have professional documents like a detailed business plan, but they won’t necessarily reject you if you’ve had financial issues in the past.
There are a few negatives to getting private investors. Some of these can be mitigated by choosing the right investor for you. Here are a few reasons a personal investor might not be the right investor choice for you.
When you accept capital from a personal investor, you give up some of your control over the business. They provide the money, and they’ll likely want some say in your business operations. Unfortunately, their vision for your company might not always align with yours. Some investors may see you — a small business owner — as inexperienced and try to get you to do certain things, like selling your business to a corporation to increase profits.
Some investors can have extremely high expectations for your business. The pressure to constantly deliver profits can be stressful. After all, you didn’t start your business to answer other people. That’s why you should get a professional to help write a realistic and sensible business plan.
Private investors may also lower your earnings. While they protect you from the risk of taking out a bank loan, you’ll have to pay private investors some portion of the business’s income. The amount of profit an investor will eat is based on where your business is in its development. For example, if your product is still being created, an investor might demand 40% of your profits to cover the risk.
Before deciding which types of private investors to approach, you’ll need to decide where your business is and how you’d like it to grow in the future. Each type of personal investor has different goals and reasons for buying into your business.
Angel investors are individuals with high net worths who usually make investments with their own money. With their investment, they purchase a percentage of your business. And because they want a high return for their money, they’ll take part in your business decisions.
There are two types of investments an angel investor might make when your business begins (the seed stage): an equity stake and a convertible note. Equity means ownership in your company. If an angel makes an equity stake investment, they are buying a portion of your business. Before this can happen, though, you and the angel investor will have to agree on how much your company is worth. For example, if you agree that your company is worth $500,000, an investment of $125,000 would buy 25% of the business. To determine your company net worth, simply calculate your total assets and deduct your total liabilities.
But what if you’re new to business ownership, and angel investors are hesitant to invest in your company? In that case, they can use a convertible note. A convertible note works like a loan. The money the angel gives you will collect interest until a specific date that you both agree on. When the due date comes, the angel can request repayment or convert the loan into percentage ownership of your company. Convertible notes give business owners and investors more time to decide what a business is worth.
Angel investors become stockholders in your company. You can try to buy them by offering them what their percentage stake in the company is worth. However, they don’t have any obligation to accept your offer. If your business fails, you don’t have to pay the investor’s money back, but they might be entitled to a portion of your business’s worth at the time of its liquidation.
Ready to meet an angel? A great resource for finding angel investors is the Angel Capital Association (ACA).
If you need a larger amount of business capital, you might try to reach a venture capitalist. Venture capitalists don’t use their own money. Rather, they work for firms that invest the large contributions of big companies and well-to-do individuals.
Venture capital firms take calculated yet big risks in the hopes of gaining enormous profits. Like angel investors, venture capitalists also have a say in the day-to-day operations of your business. For example, a firm would likely update your accounting processes to ensure the business is as profitable as it can be. This can be a bonus to new business owners who’d rather not handle their own financials.
If your business fails, you aren’t required to pay these investors back, but you may have to give them a portion of what your company ends up worth. Buying them out can be difficult, as they have huge amounts of money as leverage, and they’re not required to accept any offer you give them.
Venture capital investments can be huge. Firms will invest millions of dollars in the right company. Because there’s so much money at stake, though, firms are extremely discerning. They want to make sure a business is already succeeding in some capacity. However, they can invest in a startup if it has massive potential for growth. If you’re a freelance artist, you probably won’t be able to use venture capitalists. On the other hand, if your startup develops software that could be worth a lot in the future, you may be able to get the firm’s attention.
To further decrease their risk, many venture capital firms will specialize in certain industries. Not only does this allow them to learn everything they can about a particular field, but it also gives them a chance to focus their investments in areas with growth opportunities. A firm might only invest in technology companies and shy away from businesses like restaurants.
With a venture capitalist, it’s more important than ever to be prepared. If you manage to get in the door, have your business plan ready to go, be ready to answer any questions that come your way, and make sure your pitch is solid.
Not sure where to find venture capitalists? The National Venture Capital Association (NVCA) is a great place to seek venture capitalists for startups.
If your small business is just starting, you won’t have much use for private equity firms. These firms look for businesses that are worth millions and have shown steady growth over time. Private equity firms make huge investments.
These lending clubs use money from limited partners (LPs) to make investments. LPs can be anything from endowments and insurance companies to wealthy individuals. Unlike venture capitalists, private equity firms aren’t looking for huge gains in risky businesses. They’re looking to capitalize on the steady growth of established companies. They don’t care what a business sells, only that it has a history of success.
You might use a private equity firm if you’re looking to cash out your business or if you need to fund a new way to grow your company. These firms could buy a portion of your business or even the entire thing. They look to buy and sell companies, profit from making a business’s shares public, and share in the profits of already successful businesses. Keep this option in the back of your mind as you set about steadily growing your business and grooming it for success.
If you don’t know where to look for private investors, the federal government has some great resources. Try visiting the U.S. Small Business Administration (SBA) website to learn about the business funding programs it offers.
Small business investment companies (SBICs) are privately owned, but their funding comes with an SBA guarantee. This means that the SBA recognizes an SBIC has expertise in a certain field. It also means the SBA may double the SBIC’s investment in a small business, which lowers the SBIC’s risk.
For instance, if an SBIC invests $1,000,000 in your new financial consulting LLC, the SBA would give it $1,000,000 more to invest in your business, making the total investment $2,000,000. The SBA would also ensure that the SBIC has the financial knowledge to help your business succeed.
Approaching private investors for big money is tough, but you can do it. It all starts with having a solid foundation for your business. Put together a detailed business plan and make sure your strategies for growth are airtight. It’s also important to make your pitch as clear and polished as possible.
Before you start asking angel investors and venture capitalists for funding, though, you might try using crowdfunding platforms like Kickstarter or GoFundMe. These platforms can be great places to practice pitching your business to possible contributors. You may also be able to rely on friends and family to help your small business, whether through a loan or investment.
ZenBusiness can take on some of the stress of starting your own business. Our offerings can help you do everything from incorporating to staying on top of your business compliance needs. Building a business can be equal parts exciting and intimidating, but with ZenBusiness, you don’t have to go at it alone.
SBICs are private investor firms. These accredited investors are guaranteed and managed by the SBA. While the federal government doesn’t invest in your business directly, it does offer resources for getting funded.
The median salary for a private investor as of 2020 was $155,864. However, there’s a lot of factors that can decide how much a private investor makes.
For example, angel investors don’t invest as much capital as venture capitalists, but they may make more because they don’t have to share profits with a firm.
How your investor gets paid is up to you and the investor. Your investor might get a portion of your business profits monthly or even quarterly.
You can negotiate with your investor. In fact, it’s in your best interest to. You may disagree on things like the value of your company. You don’t want to accept a lowball offer for a percentage of your business.
The sharks featured on the show “Shark Tank” are high net worth individuals, making them angel investors.