Having a healthy business and earning you profits is happiness that every business owner has. However, it’s not admirable to see a business not growing, yet both parties can receive returns if a partnership is applied. From what I have gathered, getting your business portfolio to grow can be nerve-wracking. Many entrepreneurs don’t understand the best strategy to invest in a business to achieve this goal.
As such, as a business owner, you need assistance from willing investors. Investing in a business is the best way investors get to grow their portfolio whilst helping the business owners in their partnership attain financial independence and grow their business portfolio.
Nonetheless, the question that lingers in many minds is, how does invest in business work? Relax since this article is intended to help you as a business owner to understand the concept of investing in a business and how it works. The following are aspects to put into consideration.
Why Invest in a Business
Over and above, despite the potential rewards and profits realized from investing in a business portfolio, investors have the advantage of purchasing from an enterprise that they are very confident in.
Notably, it’s known that when an investor invests in a business, they will attract recognition. Usually, it offers an opportunity to be part of the big emerging thing in the future. So, it entails picking an exciting and promising business, walking with them in the business journey as they grow.
As a result, the investors receive recognition and earn credit since they are the first people to spot the potential business enterprise.
Also, you need to invest in a business for the purpose of offering support to the culture and traditions of innovation. In their contribution, the intention is to support entrepreneurs when they desperately need it and offer them a rare chance to grow their business into great business giants.
Besides, investing in an enterprise is a means to get innovative undertaking in areas of significant interests to you or areas you have passion in as you share for business success. Lastly, it’s an avenue to offer support to the family and friends in the new dream investment.
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How Does Investing in a Business Work
Previously, the business has been running under a general partnership or sole proprietorship. Still, they don’t offer the entrepreneurs assets because all the partners are within the business.
It has been evident that the entrepreneurs in these business engagements are not aware of the different means of financing at their disposal other than business loans.
In essence, investing in a business involves business crowdfunding or buying a section of a business run by a different entity and earning some revenue as the business grows its portfolio.
Alternatively, it involves taking an enterprise when in its early stages and funding it so long as it has the potential of growing big.
Basically, you invest funds in exchange for a segment of their equity through buying a share in the enterprise. In the event that the business achieves its intended investment goal, your shares increase in worth.
Besides, the shares can earn profits or receive payments in the form of dividends in the future. Nonetheless, if the investment fails as most of them do, you risk losing the entire investment.
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Types of Investment in a Business
There are only two kinds of investment that applied when investing in a business. Here is a detailed discussion of the two types of investment. Thus, this discussion will assist you to make a choice on which is better worth practising.
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Equity Investment in a Business
Acquiring equity investment means having an ownership stake or buying a piece of the cake. Equity investors majorly offer capital. Noteworthy, in most cases, it’s in the form of funds. These investors give cash in exchange for a certain percentage of any profit or losses.
Additionally, the enterprise utilizes the offered cash in the running of their daily business. Some of these running costs include capital expenses for expansion of the business, hiring new personnel and daily operational expenses.
In some situations, the business portion that an investor claims may proportional to the capital fund they invest in the enterprise. For instance, if you have invested $200000 in the capital, the other investor offers a share capital of $1800000. You may receive 10% of any losses or profits since you invested 1/20th of the shared equity.
Nevertheless, in some cases, ownership and dividend payments percentages can differ. The likes of Warren Buffett in his 20s & 30s had enriching investment partnerships despite having contributed the least amount in the investments. The investors received 75 % of the profit while he took home 25%.
That notwithstanding, if the expenses are higher than sales, the percentage of the losses is incurred by the investors. In the event, the business finds itself into a worst year or quarter. It may become insolvent or ruined. Aside, if the investment is thriving, the rewards and returns are primarily admirable.
Debt Investment in a Business
Making a debt investment entails returning the pledge of interest and the subsequent reimbursement of the principal amount of cash you loan when you make an indebted investment in your naïve business.
Note that the debt capita is given in three forms. One of them is by direct loans with systematic amortization. Amortization means to reduce interest at first, then the principal.
Alternatively, this loan can be sort by buying bonds provided by the enterprise. In essence, it offers semi-annual or annual interest payments sent to the bond owner.
Equally, the advantage of debt investment over other investment types in business is that it has a convenient place in the capitalization framework. The meaning of this is in case the company is ruined, and the debits enjoy priority over the partners the equity investment.
In general terms, a huge debt is a pledge secured bond with a claim of a specific valuable asset or property like a factory or plant.
Aside from an example of a case scenario, you loan funds to a restaurant and a security property on a building is given, then you can proscribe it if the restraint collapsed. However, this process is expensive in terms of cash, effort, and time.
But you ought to have the capability to regain any proceeds you can recover from the property or asset you have confiscated.
The lowest debt amount is a debenture which is backed not by a particular asset but from the creditworthiness of the business under-investment. Generally, it’s a bond sold as a loan with no fixed interest and payments.
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Would you prefer Equity Investment to Debt Investment? – Find Out which is better
The question of which of the two investments is better can be simple and challenging at the same time. If you were living in the early days of the McDonald’s business guru and bought equity, maybe you could be reached.
Alternatively, if you invested in debt investment, you’d have reaped good revenue. However, if you invest by purchasing equity and collapse, then the best option available for you is debt investment, not equity.
According to infamous investor Graham Benjamin in his study “security Analysis”, this can be a bit confusing, mentions that equity in an investment that free from debt poses less risk than indebted investment in the same business since the individual would be subjected to capitalization structure in both cases.
Equity-Debt Hybrid Investment
Sometimes, a hybrid form of investment is preferred, that is, equity-debt hybrid investment. On top of providing the best experiences in both forms of investments, models preferred stocks or shares seem to blend the worst aspects of both debt and equity. These features include limited potential debts with reduced capitalization rating of equity.
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Are There Any Risks In Investing In A Business?
These significant risks accompany a growing business or growth-focused driven businesses in its initial stages. Firstly, the establishment may collapse or take ages to achieve its objectives and goals, and this implies it’s a direct loss to the investor.
Secondly, in the event the business establishment succeeds, most likely, it may become illiquid. Notably, even a successful establishment may be locked in generally for a couple of years as the business expands.
The implication of this is that you will not receive dividends or sell shares in the initial years of the establishment. It does not matter how successful the business turns out to become.
Lastly, your business risk dilution, especially if the margin between percentages of contributions is large. To give you the sense, if this investment brings in more capital, which is evident with most start-ups, the portion of the equity that one holds decreases comparatively to what one initially owned.
In some instances, dilution is not a bad thing. But of importance is to be aware that it can disadvantage your investment.
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Benefits of Diversification
To begin with, the most significant to investing growth-driven and early-stage successfully and easing the risk already discussed is simply diversification. Without making reference to a businesses that implode, an investor should instead use of diversification to compensate for the losses.
Therefore, as an investor in a business, you have to invest in several of the great winners to receive high returns. Achieving more returns depends on your capacity to diversify your establishment portfolio through investing in several enterprises instead of investing vast amounts in a few of them.
Equally important, there is a belief that if you need an effective and efficient portfolio; you ought to have at minimum fifty early-stages as well as growth-driven businesses.
Again, according to reliable sources, investing in many companies of up to 800 may improve your performance in this light. There many online enterprises or sites that can guide you through this concept of investing in a business.
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How do you Earn Returns in Investing in Businesses?
One of the most notable means of making money through this endeavour is selling your shares in the companies at a higher price than purchasing them. Besides, there no incidental market to sell your share in a private business. That implies that you cannot make immediate stock sales.
Nevertheless, if the business develops to an extent the stock exchange floats, the company is purchased by another company with intentions of investing. Through this transaction, you earn from your stock by selling your shares at a reasonable cost.
On the other hand, you can earn returns when the business or company offer dividend payments. This is usually possible when the company or enterprise achieves profits but doesn’t foresee significant growth.
Besides, it can also occur in situations like film theatre production if the business has a bounded time frame and wants to distribute available profits proportionally.
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Precautions before venturing in investing in business
Unfortunately, investing in a business involves money. Money crops some rogue business scams practices and others. Therefore remember the following precautions to help you evade these downfalls:
Be careful on who or which company you are investing in- never invest in angels, family, or friends’ enterprises. They may be aware that the business is on the verge of collapsing, and the intention might be so that you can share the anticipated losses. If you have to invest, research intensively to ascertain that your funds will not give returns rather than losses.
Get every bit in wring- any business partnership should be done professionally and ought to bear well documented. These documents should be countersigned and will act as evidence if any of the parties complain of any dissatisfaction.
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In the public domain, investing in business has earned some people huge profits where it has succeeded. Still, some have found themselves on the receiving end after the businesses have imploded. Therefore, imperative that as an investor, you take great care and engage in a partnership with rewards rather than punishment (losses).
Finally, it’s advisable that the type of investment you settle for, whether debt or equity, should be comfortable with and worth investing in. Additionally, it ought to have fewer risks and in line with your investing culture and philosophies.
Bijay is an entrepreneur and start-up founder having more than 14 years of IT industry experience. He is the co-founder of TSInfo Technologies, a SharePoint development company.
A dedicated professional and very passionate about public speaking and also wrote thousands of technical blogs in various technologies. He also wrote a lots of blogs on entrepreneurship, investment, startup, business, manage money tips, etc.