The most important thing for every investor is seeing a return on their investment. The basic reason why investors put their money into a startup is so that they can make more money. However, business investing statistics will show you that this has not always been the outcome. A lot of investors lose their money to a business plan that had seemed “infallible”.
Investment is an aspect of business that entails meticulousness and a wide base of financial knowledge. Anyone who dives into this field must be willing and ready to know a lot of necessary steps for successful investments.
Things to Know Before you Consider Investing Into Business.
Get a Good Understanding of The Business Structure
One of the things to know before investing into business is a proper understanding of the business structure. The reason why this is important is that it will influence how the IRS and legal system view liabilities and profits.
When you embark on having a proper understanding of the business structure, you will be able to determine ahead what the odds are that the business would not succeed. In fact, Business Administration has reported that “approximately 50% of small businesses shut down within their first five years”.
Understanding the business structure may require you to follow Peter Lynch’s investment maxim: “Invest in what you know”. The more you understand a business, the more confident you are going to be about your investments.
Furthermore, understanding the business structure will allow you to know if you would be personally responsible for any unpaid bills or liabilities in case the business falls through. Therefore, we usually advise that potential investors should always think hard about limiting their liability.
We recommend that you stick with a limited liability corporation (LLC). This is because an essential characteristic of an LLC is that the owners are not usually held accountable for company debts.
In essence, understanding the business structure means you must stick to what you know well. Why would you invest in a medical business if you don’t have a medical background?
Understand the Essence of Patience
Before investing into business, you must know that you may not see any returns for years. Therefore, we call it understanding the essence of patience. Any potential investor must understand that investments are like seeds sowed into a business. Just like seeds, they take a certain duration of time before they begin to yield desirable harvests. You should know that the longer your cultivation period, then the higher your gains.
As a fresh investor, when you pump resources into a startup, you should know that the startup is going to need all the cash it can get. This means that even when profits come, they will usually be channeled back into the business for the first couple of years.
If you have any specifically targeted duration of time wherein, you’d like to earn a return of capital, then we recommend that you rather consider investing through a loan. You can adapt this method if you want to invest in a relative’s business. Nonetheless, you should still make it official by observing the appropriate business protocols.
Make Your Research
It is pertinent to expound on the essentiality of doing your ‘homework’ before investing into business. This means you need to know the background of everyone involved in the management of the business. Before you invest valuable resources in a business, you must research about the industry and the market competition.
In fact, you must ask for a full written business plan that will detail the business description, market analysis, SWOT analysis, financial strategy, marketing tactics, etc. Making your research will help you to determine if the business has practical plans to execute the ‘visions of grandeur’.
A potential investor should do a background check and pay attention to relevant details such as the professionalism of the business managers, the presentation of proposals, and the rationality of their plans. These details will give you an insight into how they will operate when they get the required funding the business needs.
In fact, in making your research, we advise that you should not make any investments in a private company without first talking to the CEO. This is because the CEO will give you relevant insights into his leadership vision and ability.
It is crucial to know that making any form of online reading or other research about a company can never be as valuable as a conversation with the CEO. You would have to consider the following questions when you meet with the CEO:
- Do you agree with the vision, mission, values, and goals of the CEO of the company?
- Does the CEO and board of directors have the capacity to carry out their vision?
In addition, making your research also means you must dig into the growth of the business. You must consider questions such as:
- At what growth rate is the business growing?
- What is the forecasted growth rate of the business?
- Is the company’s growth driven by acquiring distribution or has it been successful in increasing sales at the same stores?
In all your findings, it is pertinent to know that organic growth is far more essential than buying growth. Essentially, for an investor to understand the growth of the business, he or she must access the core financial statements such as balance sheet, cash flow statement, income statement, etc. In the case of the consumer sector, you can request for retail-level sales to help find answers to the question.
You should be able to determine how a company’s valuation and deal structure stacks up against others in the industry. Evaluate the valuation relative to comparable companies based on several factors such as capital structure, net income, risk profile, growth rate, and revenue.
You should know those good companies are not always good investments, especially if the valuation is excessively high. As the famous investment guru, Warren Buffet once said, “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.”
Ultimately, it is important for any investor to gather as much information as possible about the company, the industry, and the deal. There are no guarantees, but the more you know, the higher your chances of successful and profitable investment returns.
Consult with The Experts
Before you invest in business, it is necessary to consult with a third-party or external source. Ask an expert to vet the ‘wonderful’ projections of the business and to confirm if they are indeed credible. Therefore, we recommend that you consult with your CPA or a business valuation expert before making the final decision to invest in a business.
It is important that you find an individual who knows the industry better than you do. In this regard, you can get in touch with a professional investor in the field or an investment banker who majors in that field.
If you do not know anyone with these qualifications, then it is high time you started searching on LinkedIn. Devoting a few hours to networking will help you to understand that there are tons of questions you are supposed to be asking before diving into an investment with a business.
Interact with The Customers
It is also great to talk with the consumers or customers. Try to gather as much customer data as possible. For starters, we recommend that you discuss with at least 3 to 5 customers who patronize that business or product. The reason for doing this is quite simple. You are trying to get firsthand knowledge of what it feels to use that product and its usefulness.
You would also be getting relevant information on any loopholes that should be fixed in the product or service. In your interaction with the customers, you will have to find answers to these questions and other related questions:
- Are there any alternative products that the consumers would consider using rather than the product?
- Why would or why won’t they consider any other product?
- If another competitor drops their prices, would the customers’ loyalty be retained?
- Importantly, would the customers refer other people to patronize the business?
It is vital that you pay attention to the types of customers a company has. If the customers are promoting the products they are using, then it is a good sign that the business is worthy of your investments.
Create A Diversification Plan
It is necessary to have a diversification plan and act on it. The odds of recording success, as a private investor who is investing money in only two or three companies, are slim. According to the data reported from the Kauffman Foundation, the standard approach is to have about 7 to 10 investments.
Therefore, it is important for you to ascertain how much exactly you intend to allocate to your asset class. The importance of diversifying your investments is for you to minimize risk and maximize your chances of recording success.
Do Not Undermine the Need for Official Documentation
Legal procedures and documents that are associated with business investing in private companies are quite complex. Therefore, it is important for you to discuss with your lawyer and show every document to your lawyer for feedback. Even if you do not care about all your lawyer’s points, nonetheless you should understand their validity.
Importantly, we recommend that you do not make the mistake of investing in a friend’s or family member’s business with little more than a handshake. Regardless of how intimate the relationship might be, it is vital to draft official documents and put the terms of engagement into writing.
If you want to invest in the business of someone you know personally, then you should still go through the stress of evaluation and understanding the business structure. Thereafter, you can have legal documents drawn up and begin the business investing process.
Calculate the Per Unit Economics
It is quite surprising that a lot of businesses in recent years have attracted investors although they lose money on each “unit” they sell. However, this is not so good for their investors since a lot of these businesses also have no intention of changing this situation.
For instance, it is therefore important for you as a potential investor who wants to invest in a beverage company to understand how much that business makes or loses on each bottle. The formula for determining the per-unit economics is straightforward and simple: revenue minus total costs, including the costs of marketing and distribution.
Know the Exit Strategy
It is also necessary that you know the exit circumstances for the business that attracts your interest. This means that you should be able to consider and ascertain the following:
- How large will the business need to be, and with what margins, to go public or be a captivating acquisition target?
- In the absence of an IPO in its future, who are the potential buyers when it attains the desired scale?
- In determining your exit strategy, you must ask: “Who will buy this business in 5 years?”
Also, in planning your exit strategy you would need to draft a way to liquidate your investments. Whether your investment yields are set by time or return, we recommend that you lay out a plan for how to sell off your stake in the business. You should understand that unlike a public company that trades on an open market, you cannot sell your stock in a private corporation with the click of a mouse.
This means you must figure out how you’re going to get the money back out. It is one thing to buy in, but then it is another thing to get your equity out. You need to understand the exit strategy. You should have a ready plan to address any emergency cases.
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The key to great business investing does not invest money that you cannot afford to lose. Therefore, we advise that you should not invest in a business where your only way out is through an initial public offering. Before investing, it is necessary to learn how to invest responsibly.
Even if you do not mind losing the money, consider following these nine guidelines outlined here. This is because irresponsible investing would often lead to irresponsible business management. Make sure you can control the business before diving into the investment fully.