This article was written by Mike Capsuto, SCORE Orange County Business Mentor
Run your business idea up the flagpole and see if anyone salutes it. Unknown
Many purchases are financed through investors in exchange for partial ownership of the business. These investors range from friends and family to strategic investors. Each has advantages and disadvantages.
Information in this article is provided for general educational use only. No responsibility is assumed for any problems associated with the use of its content. One should seek the advice of their financial and legal counsel in every step of purchasing a business.
Friends & Family
Friends and family can be an essential source of funding. It is important that they understand how their investments works. Explain how you will use the money. Make it clear that you need an investment, not a board of directors. Be polite but firm. Sometimes people expect to have a say in how you run your business if they provide you money. This can strain your relationship.
• Investments sought from family may also be easier to acquire than that applied for from outside investors.
• The terms offered are likely to be considerably better than those of a professional investor.
• They already know and can trust you.
• They may be able to introduce you to some of their business associates and provide networking.
• The return they seek may also be lower.
• People expect to have a say in how you run your business if they provide you money. Make it clear that you need an investment, not a board of directors.
• Usually these arrangements tend to be made informally. Draw up all the documentation necessary to make it official. Involve your business lawyer to make sure everything is done legally with the terms of the agreement being completely understood by all parties.
• The amount that they will invest is low - $50,000 or less.
Angel investors are high net-worth private individuals who invest in businesses looking for a higher return than found in traditional investments. Many are successful entrepreneurs who want to help other entrepreneurs get their business off the ground by providing their business knowledge along with their money. There are approximately 250,000 angel investors in the US who fund over 30,000 small companies each year. They often invest in groups with each taking a part ownership in the company.
• They invest their business knowledge and networking opportunities in addition to money.
• Relatively patient about their investments.
• Their investments range between $25,000 to $1 million - sufficient to help finance a business purchase.
• They often like to invest in groups. This can be hard for owner to manage the divergent interests of a large group of angel investors.
• Are very selective in their investments.
A venture capitalist is a professional investor. He or she manages a fund and is looking for suitable investments for that fund. They may have no business experience applicable to the targeted industry and are focused only on the potential rate of return on their investment your company can provide. Venture capitalists are attractive to new companies with limited operating history that are too small to raise investment capital or secure a loan. In exchange for the high risk assumed, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the company's ownership and value.
• Typically they can provide additional capital if you need more to grow.
• Must be a fast growth business.
• Must be interested in selling the business or going public within three to five years for them to recoup their investment and profit.
• Must be prepared to share control.
These are Individuals or firms that seeks to invest in a business that complements their business strategic objectives by better enabling the products or services they sell.
• Because they are well known it enhances your credibility in the industry.
• They can provide immediate access to manufacturing, distribution, and marketing sources.
• They can provide your business with immediate contact opportunities.
• Can force you to modify your entire business to serve them.
• Dependency can be risky.
• Can prohibit you from selling to their competitors.
• They can cancel their business relationship with you on a moments notice.
Crowdfunding allows businesses that are too small or risky to attract funding from financial institutions or investors, to seek funding through the internet. Under a proposal forwarded by the Securities and Exchange Commission (SEC) companies seeking to raise $100,000 or less than would need to provide financial statements and tax returns for the most current fiscal year. Companies seeking to raise more than $100,000 and up to $500,000 would have to provide financial statements reviewed by a CPA. Audited financial statements would need to be provided from companies seeking to raise more than $500,000. The maximum that can be raised in a 12 month period is $1 million.
• Streamlined fund raising process - Crowdfunding must be done through a registered broker-dealer or registered “funding portal.” The online process allows a company to have their website and all of their documents and information in one place, so it’s a one-stop shop for interested investors.
• Crowdfunding allows entrepreneurs to review all the investors who are interested in their company, and approve or deny their investment. The entrepreneur is still very much in control of their fundraising round, and this option helps c
• Competition - depending upon what you are providing, you may encounter much competition for funding from people in the same field as you.
• Funding Limitations - crowdfunding caps the amount a person can invest in all crowdfundings over a 12-month period at 10% of annual income or net worth of $100,000 or more or the greater of $2,000 or 5% of annual income or net worth of less than $100,000.
• Cost – the cost of producing the required documentation can be extensive.
• Uncertainty- the SEC proposed rules and regulations are out for public comment. They can change in the near future.
Bottom line: Be sure you know what you’re getting yourself into when seeking investors.