The Pros and Cons of Seeking Investment in Your Startup

Written by Louis DeFelice

If you have a small business or even the idea for one, you may be considering seeking assistance from investors. Investors can provide money, advice, and opportunities which can help your business grow successfully. However, the choice is not one to be made lightly: as with anything, seeking outside investment comes with costs and benefits, a few of which are outlined below.

Pro: Investors contribute money.

The most obvious benefit of seeking and securing investment in your small business is the capital (i.e. money) that you will have access to. That money can be used to build your website, advertise, improve your tools, rent a workspace or shop, and develop your good/service.
The phrase, ‘it takes money to make money’ sums this up pretty well. Access to financial resources will allow you to grow and build your business, increasing your revenue.

Con: You will owe money to your investors.

Unlike a typical loan with a fixed or variable interest rate on which you make payments each month, investment in a company isn’t necessarily debt, it’s equity. You don’t pay back each month the money investors inject, or pay a set interest rate. Rather, investors buy ownership of your company. This means they have equity in your business. When you later sell your company, investors will be entitled to a portion of the money you make from that sale. Similarly, if your company ‘goes public,’ (which means that you offer stock to the public), investors can realize a return on their investment by selling their own ownership, or shares, of your company.

You could also agree to revenue-based financing (RBF), in which investors buy a percentage of your future revenue. They essentially bet on the successful growth of your company, but don’t own any part of it. Instead, they hope for a return on their investment by receiving a percentage of your future revenue. It is up to both of you to negotiate what that percentage is. For example, an investor could contribute $10,000 to your company. You could then commit to paying the investor 6% of your annual revenue after three years of operation until your investor has realized a return that is worth two or three times as much as they invested. RBF investors tend to expect higher-than-average returns due to the excessive risk they assume, making them more expensive than bank loans, but perhaps more accessible.

Owing an investor a distribution or a percentage of your revenue could divert much-needed funds from reinvestment in your business. However, funding your business with the help of an investor can allow your business to become more successful than it would have had you used only your own money.

Pro: Investors contribute ideas.

If you aren’t familiar with the concept of human capital, it’s the value of someone’s skills, knowledge, and experience. An investor contributes their human capital by being available to provide advice that is influenced by their experience in your sector. Particularly in the case of angel investors, who are wealthy individuals or groups making personal investments in small businesses, the relationship is more than a financial one. These investors have an incentive to offer their guidance and social capital in addition to their monetary resources because they are personally invested in the success of your business.

It is human capital, among other things, that leads experts to recommend that you seek help from several investors, not just one. When you have a diverse group of investors, you have access to a diverse set of networks, opinions, experiences, and areas of expertise. Your business will benefit from the added value of those additional opinions. Furthermore, in the case of a business’s failure, ten investors will lose less individually than a single investor would have lost.

Con: You may not agree with your investors.

While investors can, as we mentioned, provide invaluable intellectual, social, and financial resources, they might also hold a different set of priorities to you. Even when an investor is determined to see your business grow successfully, they are motivated by the end goal of realizing a financial return. For example, an investor may push for the sale of a company while you still wish to grow it independently. (Over the course of Facebook’s creation, Mark Zuckerberg turned down offers to buy the company for as little as $10,000 and as much as $15 billion.)

Because investors take on risk to support your company, and thus have a vested interest in its success, they often receive the right to vote on major company decisions. This shifts the balance of power away from you and can lead to difficulties down the road. Believe it or not, Steve Jobs was kicked out of Apple by the CEO that he hired!

When you give up independence and choose financial support, you give weight to the priorities of others: that can be valuable or an obstacle to your company’s success.

Recap and Conclusion

Hopefully these pros and cons will help you make an informed decision about whether you should seek outside investment in your small business or idea. Remember that access to an investor can entail access to financial and human capital; but it also brings a loss of independence and can lead to disagreements down the road.

About the Author: Louis De Felice runs a blog on personal finance called Wonder, Learn, Invest! Find out more on http://wonderlearninvest.com

Photocredit: Olu Eletu/ source:Kaboompics

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