How to Pay Investors Back if a Business Fails?

Are you wondering how to pay investors back if a business fails? Although this is a laudable question, showing you have good business sense and even better ethics, the answer in many cases is – you have nothing to pay back.

Of course, this is highly dependent on the type of investment and if you have any of their investment left. Still, typically investments are a risky venture as investors can and often do lose everything.

There are some cases where you need to pay investors back, even if this is not the entire amount. We will go over all this information to better understand when you have to pay an investor back, even when the business fails, and just how much you need to give back.

Types of Investors for Startups

how to pay back investors if business fails
how to pay back investors if business fails

Friends and Family

Friends and family may be your trickiest form of investment. But, unfortunately, there is a reason that genuine relationships and business do not mix. When things go wrong (sometimes even when they go right), relationships turn sour and end due to disagreements.

If you take a second to think about this, it makes sense. Whether you are an investor or a business, you want to make more money than the other. As a result, you will never be on equal footing, which is not good for a relationship’s long-term prospects.

With friends and family, you could either be dealing with a loan or an equity investor. If it is a loan, you will need to pay it back to the loan terms. I would suggest that even though you currently have a relationship with them, you still put the terms in writing. Money can damage relationships, and just because you are tight right now does not mean you will be in the future.

How you will pay the loan back will depend upon the terms. Loans are not dependent on business success, so understand that whatever you borrow needs to be paid back, potentially with interest (although sometimes friends and family do not expect interest, this should also be in the loan terms).

If the money you received from friends and family is in the form of an equity investment, this is different. Equity investors only get paid if the business succeeds. When a company fails, you do not have to pay them back most of the time.

If the business fails and you simply close your doors, and there is nothing to sell, the investors also get nothing. Suppose you have a failing business and you have assets to sell-off. In that case, you may be responsible for giving your investors a certain percentage of what those assets net. If your business fails and you still have a portion of the investors’ money, you can give that money back.

If your family and friends will become equity investors, make sure they understand how this is vastly different from a loan. Before cutting you a check, they need to know that they could ultimately lose this money if your business fails.

Most equity investors would already understand this going into any possible investment, but your family and friends may not. It is also advisable to have a contract on how they will get equity in the company and how much you are giving.

Financial Institutions

Any money you are getting from a financial institution is a loan. It will need to be paid back, regardless of how your business fares. If your business goes under, the principal and interest remaining on the loan do not disappear.

So you will still need to understand how you will be paying it back. Keep this in mind if you decide to take out a loan to finance your business.

Read: Founder vs co founder

The Government

Many Governments, including America, offer Government grants to small businesses. Unfortunately, although there is money out there, it is not always easy to obtain. But suppose this is part of your business financing and your business fails.

In that case, you can relax in knowing that this portion of your investment money does not need to be paid back.

Fellowships

It is also possible to find money through fellowship programs, but even more difficult as the competition will be fierce. However, if you do find money through this type of program, you will not have to pay it back, and you will still have complete control over your business.

On the other hand, fellowships could also be a pretty high investment, sometimes as high as $100,000.

Crowdfunding

If you choose to raise money through crowdfunding, you will also not need to pay back any raised money. Crowdfunding is just what it sounds like – it is where you put your idea out there, and many people make small donations to fund your idea. There are multiple websites where you can attempt to crowdfund.

Read: Best Business to Start in a Recession

Equity Investors

The majority of your investors and types of investments fall into what is called equity investors/investments. An equity investor is giving money based upon the sole belief that the business will make money and be entitled to a part of it.

The only way an equity investor makes money is through the success and profits of a company. If a company fails, the equity investor loses all of their investment.

Some types of equity investors include angel investors, angel groups, and venture capitalists. These are also the most likely places companies, and startups will get their investment money. This type of investment is a give and take. It has risk on both sides.

The investor is risking their entire investment on the gamble that the company will become successful. With this in mind, they invest in multiple companies hoping a few will become successful.

However, they are also well aware that they are likely to lose their entire investment. This is why they invest in a variety of industries at a time.

On the other hand, a startup knows if their company fails, they will not have to pay back their investors. However, if the company does become successful and has equity investors, they will no longer own their whole company.

Therefore, whatever percentage of their company they gave to investors is also the percentage of profit they are not entitled to anymore.

Read: Is It Possible To Start A Tech Company With No Money?

The Importance of Getting Everything in Writing

Pay Investors Back if a Business Fails
Pay Investors Back if a Business Fails

If you are searching for the answer to how to pay investors back if a business fails, you might want to think about just getting everything in writing and legally defined before even starting your business.

If this is your first business, you are probably not an expert in investing and the contracts that should come with them. Even though verbal agreements are legally binding, they are much harder to prove.

If you get to the point where your business fails, and you have lost other people’s investments and all your own personal savings. In addition, you will find it very difficult to pay for an attorney and court fees if someone sues you.

Although this is an outcome you do not want to think about, it needs to be considered now rather than having to deal with this later. For example, if you do not have a contract with your equity investor and things go south, they could claim that their loaned you money instead of invested it.

When you are making investments, whether they are genuine investments or loans, it is essential to think about every possibility and put them in a contract. Keep on reading for ideas of what to include in your contracts.

Read: 25 Best business to start to become a millionaire

Loan Contracts – Things To Consider

If you need to have a contract, you should consult a business lawyer, but here is a partial list to get you started.

  • Identify the Parties: it is crucial everyone is identified correctly.
  • Date of the Agreement: Usually, you will identify this at the top of the agreement, but often it will also be on every page of the document including near all signatures.
  • Amount of the Loan: This would be labeled as the principal – how much exactly the other party is loaning you on the loan date.
  • Interest Rate: Typically, most loans have an interest rate attached.
  • Repayment Terms: This is where you will want to be very careful to add all the essential details. Often the repayment can be made in installments, which should be spelled out in the agreement. Sometimes in a business loan, there is a grace period between the time you take the loan and the time the first payment is due to allow you time to start making money.
  • Default Provisions: Sometimes, a financial institution, bank, or other lender loans someone money, and they try to not pay it back. Because of this, there should be some kind of default provision in the loan. This should define what default is and whatever remedies are open to the lender in case of default.
  • Signatures and Witnesses: Finally, the document must be signed by the lender and the lender; it might also need to be witnessed by a notary and signed and stamped by them.

Contracts should protect both parties’ interests and layout precisely who is doing what and when, as well as the expectations of payment, interest, and what occurs when payment is not made. Loan contracts all look pretty similar.

By the time most people have started a company, they may have already signed other loan documents like student loans, car loans, or a property mortgage.

Read: 9 Modern Ways to Get Funding for Your Startup In USA

Equity Investor Agreements – Things to Consider

Equity investor agreements are similar to loan contracts. They should spell out how the business is getting the money now and how the equity will be distributed in the future. Here are some things you may want in this type of contract.

  • Identify the Parties: it is essential everyone is identified correctly.
  • Date of the Agreement: Usually, you will identify this at the top of the agreement, but often it will also be on every page of the document including near all signatures.
  • Amount of the Investment: How much money is the investor giving you. How will you receive it? Is it all at once or over a series of payments?
  • Equity Terms: What type of equity is the investor getting? Will they own a specific percentage of the company, and if so, how much? Besides equity, are they getting anything additional (many investors want preferred stock instead of common stock, which can come with other benefits like being a board member or having veto power? This means they have additional control in your company outside of the percentage they own).
  • Signatures and Witnesses: Finally, all parties must sign the document; it might also need to be witnessed by a notary and signed and stamped by them.

Typically this type of agreement is meant to protect the investor; however, it is essential to read it carefully. I would make sure it is spelled out what happens to the investors’ money if the company fails.

Do not put yourself in a situation where an inexperienced investor or even an unscrupulous investor tries to sue you for the money you do not have and never ever considered you would need.

how to pay investors back if business fails
how to pay investors back if business fails

Closing a Business Properly

When you wanted to start a business, you did not just put out a sign and open the doors. Instead, you had to take many different steps, including making a business plan, finding financing, getting any necessary permits and licenses, signing contracts, and more.

When you close a business, you have to take care of all these things again, but in reverse. Instead of getting new things and setting it up, you shut it down, canceling contracts, and make sure the business is entirely closed. All your legal obligations have been met.

Make sure you pay any final taxes, fill out business dissolution documents, file them, inventory, and sell all assets. Also, do not forget to cancel insurance policies, permits, licenses. You will also need to notify all collectors and take steps to complete all your financial obligations.

There can be legal and financial repercussions if any of these things are missed, so make sure you take your time and do everything correctly.

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Key Takeaways

Not all businesses succeed, and if this happens to you, it is essential to understand which investors you will need to pay back and which ones you will not.

Make sure you get all your contracts in writing and that they spell out everything, including a repayment schedule. Most equity investors will not need repayment if your business fails.

How to pay investors back if a business fails is an essential and ethical question to ask before starting a business. However, suppose you are already thinking of all the different possibilities, even the negative ones. In that case, you are on the right path!