Business Plans for Private Investors
Sourcing capital from private investors is one of the ways that many businesses launch their operations. This is especially true for service-based businesses or very young entrepreneurs had to not have the same access to credit as an established company or an older person. As such, many individuals will turn to professional private investors, friends, and family in order to source the capital they need in order to develop the business operations.
First, we are going to discuss working with friends and family. In many cases, a new entrepreneur will work with friends and family by sourcing a business loan from their relatives. There are a number of benefits as well as a number of drawbacks relating to this type of capital raising activity. Foremost, when you're working with family it is imperative that you have a promissory note or investment contract in hand in order to bury clearly spell out the terms of the investment. As most people do seek a loan rather than an equity investment from their relatives – it is important that a promissory note is issued so that it is clear that the individual family member is not receiving an equity percentage in the business but rather a interest payment that will be made on a monthly or quarterly basis. There have been a number of instances where a family member has lent money to an entrepreneur thinking that they were receiving a percentage of the business. In
turn, some of these businesses have become very successful where an equity stake would be worth several hundreds of thousands or millions of dollars. Many times these issues have been brought before courts given that they are our more of a handshake deal rather than a formal contract. As such, it is imperative that an attorney draft a promissory note related investment contract depending on the terms of the investment and whether or not the individual will receive an equity participation.
One of the other issues that can arise working with friends and family is that there can be bad blood if the business does not perform well. If a family member or friend lends a substantial amount of money to an individual entrepreneur and the business fails and the person is unable to repay the loan and this can cause a substantial amount of friction for the personal relationship. As such, it may be in the entrepreneurs best interest to source small loans for a number of different sources. In this case, even if things do not go well at all and the individual who lent the money will provide the initial investment is not out a tremendous sum of capital. In our experience having worked with several thousands of clients for the development of their business plans, most entrepreneurs to try to stay away from borrowing or receiving capital from friends and family given that they do not want to create any level of strife or friction within the personal
relationships. Of course, this is not always the case in many other words have developed extremely successful businesses by sourcing money from their close friends and family. It is solely up to the individual to determine whether or not this is the best way to go about things as relates to starting a new business.
A private investor typically wants less capital invested a less intensive rate of return. Most importantly, most individual private investors – or angel investors – typically do seek an equity percentage is significantly below that of a venture capital firm or private equity group. This is primarily due to the fact that most angel investors make investments ranging anywhere from $25,000 to $200,000 on an individual deal by deal basis. Most venture capital firms, private equity groups, and other private investment vehicles seek to invest millions of dollars into each project that they source. A private investor is going to want to see a return of 15% to 25% on their money on a year on year basis. This is also significantly lower than what a venture capital firm seeking that they typically want to have any lice returns of 30% to 50%.
As with any type of investment, an attorney should be hired to develop the contractual agreement between the private investor and the entrepreneur. While it may add to a slight expense as relates to the capital raising process, a very well-written contract that clearly states what everyone is entitled to is imperative in order to avoid potential litigation in the future. There have been numerous instances where angel investors claim that they own a much larger share of the business based on their initial investment. A well-written contract ameliorates all these risks given adequately spells out each percentage owned by every individual or third-party entity. In many cases, an angel investor will also provide advice and counsel as relates to the ongoing growth and development of the business. This is one of the benefits to working with a private investor, especially one that is a seasoned entrepreneur, given that they can help guide the business to
profitability during those early and difficult years. In many cases, this advice is provided on the incidental basis although some angel investors do take a seat on the board of directors or maintain a consulting contract the company as a means of generating secondary revenues. This is one of the keys that can be discussed during the negotiation process when working with one of these individuals.
When working with a private investor, an extremely well written business plan should be provided to them so that they understand your vision for growth and how they and how you intend to grow the business over a three-year to five year timeframe. This business plan should contain all of the standard elements that would be normally provided to a financial institution including a profit and loss statement, cash analysis, common size income statement, balance sheet, breakeven analysis, and business ratios page. The business plan should also contain in-depth industry research as it relates to trends within a specific market they will be operating within. Many entrepreneurs also develop an expansive marketing plan that accompanies the business plan so that the private investor can understand how the business will position itself within the market, obtain customers, identify the customers that they are seeking, and over viewing any competitors within the
market at the business will face on a day-to-day basis. Although this difficult document to write, there are a number of consultants and writing firms that can assist individual with developing their business plan and marketing plan.
In closing, private investors are a great way to raise money for a new business. Generally, they do not consider the individual entrepreneurs underlying credit score when making an investment decision. Private investment funds typically focus significantly on the economic viability of the business rather than the businesses ability to make monthly interest and principal payments. Working with private investors also allows the business a much greater timeframe for becoming profitable given that most financial institutions want to see that profitability is reached within the first six months to twelve months of operation. Again, the key focus of when working with a private investment firm one individual angel investor is to make sure that there are significant legal safeguards in place so that the investment contract clearly states who owns what, the expectations of the business, and the patience of the individual entrepreneur.