An investor is anyone who invests money into a company with the purpose of taking ownership interest in that company. An investor places their money into the business to assist the business in growing and developing, in order to generate a large financial return after the term of their investment is up. This Legal Kitz blog will cover all you need to know about sourcing the right investor for your business.
What is an investor?
An investor has the ability to invest money into a company that does not offer shares. For example, many investors choose to invest money into a start-up company, in the hopes that the company will excel in later years. The major thing to consider when deciding to become an investor is to look for the potential profitability of the company. Many investors put money into companies in the early stages of the business, in order to provide the business with the funds to build, grow and develop their brand. The main purpose of investing in a company is to receive a stake or return from the business.
What are the advantages and disadvantages of having an investor?
Advantages
Sourcing an investor comes with many benefits, including:
- Cash injection into the business to overcome financial difficulties
- Investor knowledge and experience
- Reduced pressure to repay
- Investor may provide valuable industry connections
- Improves stakeholder confidence
Disadvantages
- The business owner will lose something as a result of an investor loaning money or buying equity
- The investor may want a significant level of involvement in the business
- The investor may have different long-term goals for the business meaning that your investors’ interest in turning a profit uncomfortable and a chronic source of disagreement
- The entrepreneur’s willingness to take on more risk for the sake of the reward will clash with your investors’ fears of losing their investments.
What is the difference between an investor and a shareholder?
The terms investor and shareholder are often used interchangeably within conversations, however, did you know there are distinct differences between them?
A shareholder is anyone who buys shares in a company that distributes shares. These shares mean that you own part of that company, therefore, the more shares you own, the higher percentage of ownership you obtain. Shareholders can choose to sell their shares to make profit or wait until the company decides to pay dividends. Generally, shareholders have the right to:
- access financial records;
- sue company directors for any wrongful actions;
- vote and engage in corporate decision making; and
- trade or transfer their share ownership.
An investor, on the other hand, invests money into the business to assist the business in growing and developing, to gain a financial return. Unlike shareholders, investors can invest money into a business that does not distribute shares.
What types of investors are there?
Angel investors
An angel investor refers to a private investor or seed investor, who is a wealthy individual providing financial backing for small startups or entrepreneurs, typically in exchange for ownership equity in the company. Angel investor funding is typically sourced from an entrepreneur’s family and friends. This investment can either be a once off payment to help kick-start the business, or through continuous injections of financial backing to help aid the company through its early stages.
A great example of angel investors are the sharks from shark tank. The sharks will assess the company’s pitch, and decide whether or not to provide capital (money) for companies with potential for growth in exchange for equity stake. These sharks most often will invest their own money to make a profit, however, few sharks are venture capitalists in which they come from VC firms.
Venture capitalists (VC)
A venture capitalist is a professional investor who takes a share in a business, with the prediction that the business can grow rapidly and enormously. Venture capitalists will often find and support a business if it has been successful so far, and if they believe that the product or service has great earning potential for the future. They will actively be involved in the business, usually by joining the board, to have a say in the company’s direction and to protect their investment.
While venture capital firms are listed online, the most promising method for receiving funding is to get recommended by a business advisor, lawyer, accountant, or other industry source.
Equity crowdfunding
Equity crowdfunding allows private companies (and public unlisted companies) to source funding from public investors by offering a stake in their business. Companies who are eligible are now able to source up to $5 million per year within Australia. This most generally is most successful in B2C companies who sell products or services rather than BSB businesses.
Peer-to-Peer lending (P2P)
P2P lending follows a more personal approach in which an individual requires a personal or business loan from an investor, without the need of going through a lender such as the bank. The borrower will take out the loan and repay this back over time, with interest.
Incubators and accelerators
Incubators and accelerators offer entrepreneurs opportunities to quickly grow their business and provide advice to better the chances of attracting a top venture capital firm to invest in their startup.
Incubators work with small companies or single entrepreneurs who are in the initial stages of their business. Incubators will aid these companies to find the optimal conditions of growth and help them maximise their potential. Many incubators are independent, however, some are sponsored or run by VC firms, government entities, etc.
Accelerators will conduct an application process where they select individual companies to receive a small seed investment and access to a large mentorship network in exchange for a small amount of equity. Many mentors include venture capitalists, industry experts, etc. which offer the greatest value of small businesses.
Corporate investors
Corporate investing involves a company that is looking to acquire control over, or become involved with, another company. The company will therefore invest in the other company allowing it to receive a stake in the business and acquire a certain level of control.
Banks and financial institutions
Conventional banks can be used to source a business credit card and/or advance loans, however, they do not offer capital for companies and independent ventures.
There are government programs that aim to provide grants to businesses within certain projects. These loans will require regular repayment, this can ultimately influence your productivity and ability to fund-raise from different investors in the future. This type of investment funding also comes with certain limitations and restrictions that may not agree with your business model.
What makes a good investor?
Although the concept of an investor sounds extremely enticing, it is essential that you thoroughly analyse whether the investor is a suitable fit for you and your business.
There are certain qualities that it is important to consider analysing your possible investor candidate. The investor should ideally be:
- Someone with industry experience – an investor is a mentorship opportunity, so someone who has experience, contacts and passion for that industry can provide value.
- Someone who is connected – an investor offers better networking opportunities if they are connected to other investors or valuable connections.
- Passionate and dedicated – an investor should want to stay committed to your business for the long-term and with this comes a certain level of passion for your idea and dedication to your goals.
- Do you personally get along? – It is important to have an open and trustworthy relationship with your investors, so it is equally important to ensure you will be able to personally work together
- Lives locally – the ideal investor lives relatively locally which allows you to constantly contact them and access their knowledge and skills whilst also ensuring that your business is still highly relevant within their life.
What does an investor look for in a business?
- Business plan for the future
- Investors want to know what the overall plan for your business looks like, which allows them to make a judgement call on your expected potential. Our sister company, Business Kitz, offers a business proposal template which allows you to fully structure all of the important business details that an investor would want to know.
- Growth potential
- Highlight the potential growth the business will achieve, as investors want to ensure that the financial risk they are taking is backed by belief that they will see a return on their investment.
- Valuation
- Valuation is sourced from actual business numbers including sales, gross margin, and fixed costs. This allows investors to specifically understand the value of the business they are receiving when they purchase a certain amount of equity.
- Market size
- Investors need to know how many people your product/service will actually appeal to. If the market size is limited this raises a red flag as to whether your company can actually maintain high growth in the future.
- Level of involvement in the business
- Many investors want to be personally involved in the business to safeguard their investment and help the business grow. They will therefore want to ensure that the founder is open to listening to their advice.
- Defensibility
- A big selling factor is whether or not you can defend your business against competitors. Investors need to know that if a competitor comes along, the company will still thrive. This may include patented products, secret ingredients, trade secrets, relationships with channels of distribution, and even branding.
- Personal investment
- Investors want to know if you are willing to invest in your own business both personally and financially. If you are unable or unwilling to put your own time and money into the business, then why should they?
Legal advice
If you are interested in sourcing an investor but are unsure about how to best safeguard your business ownership and decision-making abilities, Legal Kitz can assist you. To arrange a FREE consultation with one of our highly experienced solicitors, click here today, or contact us at [email protected] or 1300 988 954.