8 Rules For Investing in Someone Else’s Business

Whether you have decided on your own to start investing or have been asked for investing in someone else’s business, it is a big financial step and deserves careful consideration.

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Investing your money into someone else’s business is always a risk, and it can yield a great reward or become a loss. Investing is not something you should jump headfirst into.

But did you know that before you invest in another company, there are many factors you must consider?

What Should an Investor Consider When Making an Investment

1. Business Plan is Required

Any business you are considering investing in should show you a well-written investor business plan. This plots out their plans for the future and indicates how they think their business will grow and what they plan to do when things don’t go as planned.

The company’s target market should be identified, and the financials must be clearly laid out. If you have trouble understanding any part of the business plan, take it to a professional for advice.

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2. You Select your Investments

Don’t blindly acknowledge a companion’s or relative’s pitch. If you haven’t set up your own investment objectives, don’t put resources into anything until you do so. Without your own goals or principles, you lack a basis for assessing the opportunity. You leave yourself helpless against the attempt to seal the deal that sounds great.

3. Calculate Your Downside Risk

There is always a risk in investing in someone else’s business. The pitch is meant to make it seem like a sure thing. Do research on similar businesses and the competition. Compare what the company is asking for the amount of risk you’re taking and make an educated offer. This will help prepare you and protect you from investing too much or making a bad investment.

4. Paperwork

Once you define your goals and decide how much you’re willing to invest, get everything in writing, even if you are investing in a friend or family member’s business. This will ensure there are no misunderstandings and protect both parties. Having the proper paperwork will also help you stay organized and keep track of your investments.

5. The Founder also has Something to Lose

Try not to get into a business where the originators have nothing to lose. Make sure the originators will lose cash or end up in debt if the business comes up short.

The business needs to have impetuses and disincentives for the board and the founder. Otherwise, they might work a useless business as long as your cash turns out revenue to them.

6. Investment Goals

This is 2nd most important rule for how to invest money. Before investing in someone else’s business, you need to define your investment goals.

How much do you want to get back for your investment? How long do you want to wait for your investment to return? What kind of stake do you want in this business?

This easy-to-use profit margin calculator allows you to estimate how much you can earn on specific investments

7. Don’t Invest Money that you Can’t Afford to Lose

Be sure to invest responsibly. Don’t invest more money than you can afford. Check all laws and tax laws surrounding your investment. Always air on the side of caution; if it sounds iffy or wrong, steer clear.

8 Rules to consider when investing in someone else’s Business

Investors put their money into startups to make more money. Investing statistics, however, show that this has not always been the case. Several investors lose their money on an infallible business plan.

Research the following 7 areas before deciding to invest in someone else’s Business

1. Analyze the Business Model of the Company

Regardless of which business model a company uses to make money, successful businesses should position themselves to maximize profits. When studying a company’s business model, make sure you learn about its products and services, target market, and industry.

Some companies (like eBay) are targeting a wider audience with lower prices and higher sales volume. There are some companies (like Apple) that create exclusive products that customers gladly pay for.

A number of business models are viable, but be sure to understand the underlying operating principles before investing.

2. Assess Annual Net Income Growth

A company’s net income can also be a good indicator of growth. Profitability can be determined by this number.

If a company’s net income decreases year over year, it may not be sustainable. This may be an indication of inefficiency and a rapid increase in its expenses. Increasing net income over time indicates that the business is operating efficiently and growing.

Any company’s ultimate goal is to make a profit, which directly affects the stock price.

3. Examine the Profit Margin

A company’s profit margin is the percentage of revenue that it takes in as profit (after expenses, interest, and taxes have been deducted). This is the net income as a percentage of total revenue.

Suppose a company has a revenue of $10,000,00 and a net income of $1,000,00. The profit margin is 10%.

Profit margins that remain steady mean a company can keep prices low and its operations efficient. Increased profit margins often indicate that an enterprise is a leader in its field and can command higher prices.

Steady and/or growing profit margins are a good sign for investors, as those profits should reward stakeholders with returns.

Calculate your business profit margin by using wise’s profit margin calculator.

4. Understand the Essence of Patience

If you invest in a business, you should know that you may not see any returns for years. Thus, we call it understanding the essence of patience. Investments are like seeds sown into a business. Seeds also take a long time to produce any desirable results.

When you invest in a startup, you should realize that it will need all the cash it can get. It means that for the first couple of years, even profits will be reinvested into the business.
If you are looking to earn a return on your capital over a specific period of time, then we recommend that you invest through a loan.

If you want to invest in a relative’s business, you can use this method. You should still follow proper business protocols in order to make it official.

5. Consult with The Experts

An external source should be consulted before investing in a business. Therefore, we recommend that you consult with an expert in business valuation when planning your investment in a business.

Finding someone who knows the industry better than you is crucial. For this purpose, you can contact a professional investor or an investment banker specializing in the field.

6. Create A Diversification Plan

It is essential to have a diversification plan. If you invest money in just two or three companies, the chances of your recording success are slim. Kauffman Foundation data indicates the standard approach is to have 7 to 10 investments.

For this reason, you should ascertain how much you intend to allocate to each class of assets. Diversifying your investments will minimize your risk and maximize your chances of success.

7. Official Documentation Must not be Undermined

Investing in private companies involves complex legal procedures and documents. It’s important that you discuss all of the documents with your lawyer and show him each one for feedback.

You should not invest in a friend’s or family member’s business based on a handshake alone. No matter how intimate the relationship might be, it is necessary to draft official documents and put the terms of the engagement in writing.

You should still evaluate and understand a business structure if you want to invest in the business of someone you know personally. You will then be able to have legal documents prepared and can begin the business investment process.

8. Keep Duplicates of all Documents

Remember to save duplicates of all paperwork for the substance. For a corporation, keep duplicates of minutes, standing rules, articles of incorporation, and shareholder agreements. For partnerships and LLCs, keep copies of the agreements which establish the entity. Keep the original notes on your advance in a protected place.

Conclusion

Investing in someone else’s business isn’t easy.

Investing in a company you don’t work for every day can be risky, and most entrepreneurs don’t jump into this kind of business without first doing their due diligence.

Any investor considering investing in a company of any size should first take stock of the risk involved. It is not only a matter of knowing if your money can be wasted – but also of seeing if there are aspects to the enterprise that make it more likely that it will be a good investment or not.

Frequently Asked Questions

Can your business structure affect your ability to attract investors?

Do you know that the business structure you choose for your small business can make it hard for you to secure funding to build your company? If you don’t form a business entity that suits their preferences, investors are less likely to invest in your business.

Which business forms are most attractive to investors?

Investors want to limit their risk. It generally means that a company that provides a liability shield is preferable. Putting in capital and sharing in profits allows an investor to become a partner in a partnership.

A general partner has no liability shield, while a limited partner’s liability is limited to their contribution. The members of a limited liability company (LLC) are also limited in their liability.

Recommended: Learn how to form an LLC in your state or choose Wisebusinessplans to make your LLC registration hassle-free.