Investor financing is unique because it often involves ownership of the business rather than a loan that has to be repaid. You can finance your business by bringing on an investor or a group of investors. The investors will contribute money to finance the business and, in exchange, they will receive some percentage of ownership of the company.
The investors aren’t repaid for the money they contribute. Rather, they receive income from the business and may sell their share at some point in the future if they wish. The investor takes on the risk that they could lose their investment if the business doesn’t work out.
Investor financing can be a good option if you are comfortable with bringing on other owners. However, by accepting investors, you are also giving up ownership and some control of the business. Terms and roles should be clearly defined so you don’t lose control of your dream. Otherwise, you may find that you’re running a business for your investors rather than for yourself.
Investor Financing Pros:
- Financing doesn’t have to be repaid like a loan
- Doesn’t impact your credit
- Investors may have skills and ideas to improve the business
Investor Financing Cons:
- You must give up share of ownership
- You may give up or lose control of the business
- Brings other owners’ personalities and priorities into the business
Sometimes, an investor can be the missing ingredient needed to elevate a business to a new level of success. An investor can bring unique knowledge, skills, and experience to help the company grow. They may also bring connections and a large pool of prospects. Perhaps most importantly, an investor can bring money, perhaps enough money to resolve cash flow problems and fund new growth.
However, an investor isn’t right for every business. The expertise and funding often have strings attached, and those strings may not be right for you. Your investor will likely want a share of the company’s profits. He or she may want decision-making authority. They may even want full control of the business.
Before you dive headfirst into an investor agreement, take some time to consider whether it’s the right option for you. Here are a few important questions to ask yourself:
Are you willing to share a high percentage of your business profits?
It’s important to remember the difference between an investor and a lender. When you borrow money, you have an obligation to repay the lender. You usually have a fixed payment schedule, and you must make those payments regardless of how well or poorly your business is doing.
Even if your business is failing, you’re still obligated to repay the loan. However, if you are very profitable, the lender has no access to any funds beyond your required payments.
That’s not necessarily the case with an investor. When you take on an investor, you may not be obligated to a specific payment schedule. That can be a good thing. If the business is struggling or if cash flow is tight, you’re not tied to burdensome debt payments.
However, an investor will likely want to cash in when the business is successful. They may want a percentage of the profits. If you sell the company, they will likely want a portion of the payout. While an investor can bring much needed funding and expertise, they will also take a portion of the financial reward that comes with ownership. Think about whether you are willing to include someone else in your profits.
Are you willing to let unfamiliar people participate or take control of important managerial decisions?
When you bring on an investor, you are bringing another owner into the business. They have capital at risk in the business, just like you. That means they may want to offer input as to how the business should be run. They may want a say in hiring, product design, and your plans for growth. They may even want to bring in their own employees.
Of course, one way to limit their input is to limit the size of their equity stake. If an investor owns only a few percent of your business, it may be difficult for them to make demands or offer strong input. However, the larger the equity stake the more influence they will likely want to have.
Taking a large amount of investor funding can be tempting. Before you sign the deal, though, consider how much decision-making authority you are willing to cede to someone else. It may pay to take less funding and retain more ownership of the business.
Did you start your business to ultimately work for someone else?
In some instances, your investor may demand significant control of the business in exchange for their funding. This is especially true if your business is struggling and desperately needs an infusion of cash. The investor may use their leverage to request more influence and decision-making authority.
The question to ask is whether you are ceding so much control that you are essentially turning yourself into your investor’s employee. Do you control the business? Do you answer to the investor? Does the investor have the ability to fire you from your own business?
If you don’t want to be someone else’s employee, then you an investor partnership may not be for you. At the very least, you may want to create a document that specifically states how much authority the investor has.
Does the investor truly add value beyond simply the money?
Many business owners consider investors because the business faces financial challenges. Cash flow may be tight. The business may need money to expand. The company might not be able to fulfill orders because they don’t have the cash to buy supplies. An investor can solve many financial issues.
However, the best investors bring much more than money to the table. They could have experience in your industry, which allows them to serve as a mentor or advisor. They might have connections that could open up new markets. Or they may be able to fill a critical void, such as chief financial officer or VP of business development.
Look beyond the financials when considering investors. Ideally, you should partner with someone who can help you overcome strategic challenges in addition to financial obstacles.
Do you have a clear and feasible exit strategy with the investor?
Far too often, business owners are so excited about the possibility of investor funding that they don’t look at the big picture. They fail to negotiate issues of control and authority. More importantly, they don’t create a defined exit strategy.
The exit strategy is the mechanism by which the investor leaves the business. Most investors aren’t looking to be involved in a business permanently. They want to make an investment, help the business grow, and then get a return on their money.
Similarly, you shouldn’t view your investor as a permanent partner. They may be helpful for a few years, but eventually, you’ll likely want to retake control and full ownership of the business.
Talk with your investor about potential exit strategies. Can you buy them out at some point in the future? Could you gradually buy down their equity stake over time? What requirements do you need to meet for them to feel satisfied with their investment?
Take time to discuss the unwinding of the partnership, and, if possible, create an exit strategy document. Doing so could eliminate a great deal of stress down the road.
Not sure whether investor funding is right for you? The good news is that you have other financing options available. Bank lending could be a good solution, as could funding from family and friends. You also may want to consider factoring, which allows you to get funding for your outstanding invoices without committing to a burdensome payment schedule or giving up equity in your business.
