Having enough cash to start and run a business is a challenge many entrepreneurs face. The money shortage leads many to source for outside funding through traditional loans, cash from friends and family, or applying for microloans.
Others seek funds from investors to grow their business. If you happen to be a potential investor, getting a few aspects clear before committing your monies is vital. For every investor, getting a return on investment is the top goal when putting their money in a startup.
However, this is not always the outcome, and many investors end up losing money to businesses that seemed scalable.
Financial knowledge and meticulousness are critical to a successful investment. It would be best if you are ready and willing to go through several necessary steps before coming to your final decision of investing in the business or not.
Things to Know Before you Consider Investing in a Business
Here are a lot of things to know before you consider investing in a business.
1. Understand the business structure
Understanding the structure of a business is one of the things to know before investing in a company. As an investor, proper scrutiny of the business structure helps you determine the odds of the business not succeeding. Research has proven that approximately 50% of startup businesses collapse within the first five years of operations.
A proper understanding of the business structure is also vital as it influences how the legal system and Internal Revenue Service view the profits and liabilities. It also sheds light on whether you would be responsible for liabilities and unpaid bills. Limited liability corporations are a safe space for investors as they would not be held accountable for the company’s debts.
To properly understand a business structure as an investor, you need to invest in what you know. The more knowledge you have in that particular field, the more confident you will be about your investment. It would be absurd to invest in a medical business without any medical background.
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A consolidated plan and a unique idea are not all it takes to have a successful business. Having management able to execute and effectively run the company is more important.
Before investing in the business, as yourself the following questions:
- Who is the company’s manager?
- What is their experience level? Their failures and successes?
- What background do they have?
Ensure to know as much about the management team as you would the product or service.
3. Do Your Research
We cannot insist enough on the essentiality of conducting comprehensive research before investing in any business. Ensure to research the market competition in the industry before investing your valuable resources.
Conduct a background check on everyone in the company’s management positions to establish their professionalism and ability to deliver. Examine the rationality in planning and presentation of proposals to gauge how they are likely to operate once they receive the needed funds.
When looking to invest in a private business, it is pertinent to organize a meeting with the CEO. Online research cannot be as valuable as a face-to-face meeting with the founder. Personal interaction with the founder gives you insight into their vision, ability, and leadership skills.
Ensure you understand the growth of the business by asking for core financial statements like the balance sheet, income statement, and cash flow statement, among others. You may also look at retail-level sales records to establish the progress of the business.
You can also compare the company’s valuation based on risk profile, net income, and revenue to other comparable companies in the industry.
After conducting your research, consider pondering on these questions to help you arrive at your decision;
- Does the mission, vision, and values of the company resonate with you?
- Is the board of directors and CEO capable of executing their vision?
- What is the growth rate of the business?
- At what rate is the business forecasted to grow?
- Gathering as much information as you can about the company and its industry is vital. Despite there being no guarantees, the more information you have, the higher your chance of a profitable and successful investment.
4. Consult with Experts
Consulting with a third party before investing in a business is necessary. Consider having a valuation expert or a Certified Public accountant vet the business projections to confirm their credibility before making your decision.
You could also consult a person with more knowledge of the industry than you do in their opinion on the feasibility of the investment deal. A professional investor or investment banker with experience in the field could also have some nuggets of wisdom to help you with decision-making.
If you do not have an expert to consult at your disposal, consider networking on platforms like LinkedIn to help you understand what you need to consider before investing in a particular industry.
5. Select your Investment
Avoid being “sold” investments. You could have friends or family pitching to you, leading you to invest in businesses you had not intended to. Ensure to have your investment goals in place before accepting any pitch that comes your way.
Without proper investment goals and standards, you become vulnerable to any idea that sounds good to you as your assessment base lacks. Ensure every investment you consider meets your criteria and that you do your due diligence before getting involved.
6. Require a business plan
Never consider investing in a business without a business plan. Insist on looking at the business plan of any company that proposes your funding. It provides enough details to help you determine the feasibility of the business and gives you insight into how the business intends to make money and meet the expected return on investment to investors.
A good business plan will expound on;
- Financial projections with numbers to illustrate
- The target market and reasons for targeting that market
- A precise analysis of how the company is distinct and unique from its competitor
- The channels of sales and why they are the most effective channels to use
- A Data-driven and realistic marketing plan and goals
- Potential risks and challenges of the business
- A well-calculated timeline that the company expects to see returns on the made investments.
- A business plan gives you a wholesome idea of the business’s operations and structure, hence the importance of requiring this document before investing.
7. Examine what the founders stand to loose
Nobody wants to invest in a business whose founders have nothing to lose. It only indicates the little faith the founders themselves have in their business. Therefore, as a potential investor, it is essential to establish what is at stake for the company’s founders to lose if things go left.
When founders have a lot to lose, the fear of loss is motivation enough even when the possibility of succeeding isn’t.
With nothing to lose, they may relax and run a worthless business as long as your investment gives them an income.
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8. Need for Documentation
Putting your hard-earned money and valuable resources into someone’s company is not a process to officiate by word of mouth. Documents and legal procedures involved during investing in private companies may be complex, but you don’t have to do it yourself.
Ensure to have your lawyer on board to guide you through the process. It is also advisable for you to be aware of each document, its purpose, and its validity.
Investing in family or friends’ businesses may often lead to you having your guard down due to the relationship involved.
Despite how intimate the relationship is, drafting an official document and putting your engagement terms in writing is vital. Remember to do your due diligence by evaluating the business plan and structure.
9. Current State Of The Company
Understanding the current state of a company before investing is also essential. Is it already established and looking to expand, or is it still at the startup stage? Is there a story or narrative behind the founding of the business?
It helps to understand the business from all aspects to make the decision-making process easier for you. What solution does the company offer? What problem does it address?
All these questions help you understand the essence of the company better before investing.
10. Growth opportunities
Evaluate the room for growth that the company has. Does the company you want to invest in intend to grow into other new markets? Does the business have the drive to have new products or services in the future or extend the current ones to new markets?
Find out where the company sees itself in the next 5years or even 20 and how they intend to get there. Your findings on the opportunity for growth in the business you intend to invest in should inform your decision on funding.
11. Your Exit Strategy
There may come a time when you want to exit the business, whether it is performing exceptionally well or not. It would be best if you established how your exit plan would look like.
Will it be possible to sell your shares to another party in the company, or will the company repurchase the equity? How do you get your money out of the company?
When planning your exit strategy, ensure to draft how your investments will be liquified. Unlike in public companies where you can trade your shares in an open market, you need to plan how to sell your shares in the private business.
As you plan your exit strategy, it is also wise to consider the business exit circumstances that could benefit you. Ascertain;
The margins to achieve for business to be big enough to go public or be an enticing acquisition target to more prominent corporations
Potential buyers of the business once it attains the set margins.
It is one thing to buy into a business and another to remove your equity. Ensure to have an exit strategy in place and have a plan that addresses emergency cases.
Invest the money you can afford to lose.
Never invest money you can’t afford to lose. The money you put aside to invest in a small business should not be money you will need to access soon.
Once you put your money in a business, it gets tied up and completely illiquid, taking a long time to have it freed up.
Also, read, Best Business to Start in a Recession.
12. Evaluate your downside risk
Consider all possible outcomes of the business. What circumstances will cause the corporation to fail or succeed? Will anything be needed to break even the business? What happens if you require more money to boost the company at some point? Will it be available, or is the business going to fail due to cash shortages? Will you be willing to provide more funds for the company or not?
In business, make no assumptions; anything is possible. Evaluate and determine for yourself all possible occurrences before investing.
13. Time Horizon
Your time horizon is the period you are willing to stick with an investment in a company. Do you expect to generate your returns over a few days or several years?
Every potential investor needs to establish their time horizon to select a suitable investment for themselves. It helps the investor stay the course.
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Researching your investments before diving in is pertinent to having a successful investment. It helps you avoid pitfalls that new investors and sometimes veteran ones fall into.
Remember to invest responsibly. Even if the beneficiary of the investment is your child and you can afford to lose the money, avoid recklessness. Require every business you invest in to meet your standards and have business planning of high standards.
In a nutshell, when settling for a company to invest in, ensure that;
- You agree with and understand the leadership and business prospects.
- The company has strong management and is financially healthy
- Has a comprehensive business plan
- Has unlimited opportunities for growth a
After putting the tips discussed above into consideration, your investment decision will be an informed one and bound to succeed, giving your expected return on investment.
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.