Would you like to help someone else get their business off the ground? Investing in small businesses is sometimes a risky endeavor. Venture capitalists usually invest in a bunch of companies, fully expecting most of them to fail.
However, when the some of them succeed, their returns outweigh the losses. Small businesses can grow exponentially if their products take hold. When looking into investing in a small business start up, there are several things to keep in mind.
Why are you investing in this company?
There are several reasons to invest in companies. Sometimes you can get a good feeling for the prospects of a product simply by being around it and trying it out. If you think there is a genuine need for something, then the product alone can sometimes carry a company.
Another reason would be a great base of talent in people. If you are experienced with the employees and management of the start-up, you may have confidence with their decision making capabilities. This is touchy reasoning, because even if they have the best people around, they need a product to market and a business model to follow. Sometimes great minds can produce great failures.
It is usually best to have a combination of both of the aforementioned reasons. Great people combined with a great product idea or business model can usually give you some confidence in your investment. Of course, in this business, nothing is guaranteed.
Can you afford to lose all your money?
This is a very important question. As always, when investing in the market, you must be realistic about the prospect of losing everything. Although it is a little less likely in efficient, open markets, it is still possible. Just look at the Enron or WorldCom debacles and say that you saw that coming. Sometimes things happen that are simply unforeseeable.
Therefore, it is very important that, as an investor, you can afford to take a hit in the pocketbook. If there are questions about this part of the decision process, you should carefully reconsider your investment.
When investing in an entity that you have an emotional interest in, such as a good friend's start up business, it is important to not buy too much into your feelings. First, it is necessary to consider whether or not you can actually afford to help as much as they need. If not, they can find other methods of financing.
Usually, friends and family are the first forms of financing petitioned by a start up business. Don't feel bad about declining an offer; your primary responsibilities are to yourself and your family.
What sort of control will you have?
As an investor, will you have any say in the direction of the company? Will there be any sort of control?
The worst type of investment is a minority investment in a privately held company. In this sort of arrangement, you have no control over the company decisions and no way to pull out your money. It is best to at least get some control out of the deal. Also, is the investment treated like a loan in the contract? Is there a form of required return written into the contract? This is also important to ensure that you get at least a marginal return on your investment.