6 Effective Rules For Investing In A Small Business The Right Way
Generally, investing in a small local business is a significant financial decision. Such business ventures offer an opportunity to watch a business grow and gain from its achievements along the way. However, if not done right, investing in a small business can end up costing you more than you are prepared to lose. So, the question is: How can you ensure that you are investing in a small business the right way? Here are some of the tips seasoned investors have recommended, and you should consider them before taking this financial step.
1. Invest an amount you are ready to lose
The small business of your choosing may have great potential. They may have an excellent product or service, and you are confident that they would make a big wad of money in no time! Based on this belief, you may choose to invest a lot of money, hoping that you gain a lot in return. Although this sounds like a good idea, it really is not. Statistics have shown that about 60% of small businesses fail within the first year in the UK. This means that your company of choice may not be making as much as you would think it should. To avoid suffering from a wrong investment decision, you should invest an amount of money you are comfortable losing. On the other hand, many small businesses are illiquid and are unable to give you your returns on time. Therefore, putting in what you are ready to lose would prevent you from being low on cash or expecting money that may take too long to come to you or may not come at all.
2. Conduct some research
Before you go ahead to give the business your money, you should conduct some thorough research. Documents such as the business plan, profits and loss statements, forecasted cash outflow and inflow, budgets, and so on help you determine if you should invest in the business and how much. The business plan provides you with detailed information on how the business owner plans on running the business. It touches on essential areas such as the mission and vision of the company, the nature of operations, expected expenses, and revenue. With this information, you can determine if investing in the business would be feasible. You should check if the business has professional liability insurance and other forms of business insurances to ensure that your investment is safe.
3. Talk to the owners
Although the documents mentioned above would help in making your decision, you would have some questions. Take some time to interview the owner(s) of the business to have your various questions answered and learn more about the business. During your interaction with the owners, ask them questions about their goals for the company, their target audience, and the management approach they would like to use in conducting operations. Most importantly, you should ask them how much they stand to lose if the business fails. No investor would want to suffer the loss alone. If the owners have a lot to lose if the business goes down, you are confident that they would work hard to prevent a loss, making your investment worthwhile.
4. Do not invest based on the hype
Your family and friends may be the first people you would contact when looking for an investment opportunity or need advice on joining one. Or perhaps, they are owners of a small business themselves. Whatever the scenario, be sure not to enter an investment based on a good pitch. Being sold to invest can end up costing you more than you bargained. This is because you may not have established your goals for the investment before you entered. In other words, you may not be ready to take risks or do not even need the investment! Therefore, instead of jumping on every investment opportunity, regardless of how good a pitch you receive, ensure that you draw up a plan. If it does not satisfy what you hope to achieve, do not go ahead with it.
5. Calculate the risks involved
Investments are a wise financial decision, but they can also be risky. Some of these risks may be manageable and worthwhile, while others may be the complete opposite. This means that you should calculate the risks involved with investing in a particular company before deciding to do so. Start by determining the various possible outcomes. Ask yourself questions such as: how long would the business be in operation? Would they need more money? Is the interest I would be receiving worth the money I am putting in? Questions like this widen your perspective on all the possible risks that may incur. Therefore, do not put a limit to these questions by saying, “that cannot happen.” If you do, you may end up panicking when you are confronted with a risk you thought could never happen. Once you have calculated the risk, you can determine if the investment is worth making or if you should wait for another opportunity.
6. Keep records of your agreements
Once you are confident in your decision to invest in the business, it is time to keep records of your agreement. First, you should get everything in writing. Usually, especially when doing business with friends and family, it is understandable that you may want to rely on oral agreements. However, this often brings about conflict and ruins a good relationship. To avoid this, write down your investment terms and have them signed by you, the business owner, and a witness. Ensure that paperwork is in order, clearly stating the terms and conditions involved. Where there are issues concerning collateral, be sure to address this clearly in your contracts. This would include what is up for collateral and the process in which the owners would transfer the assets to you. Make copies of any documents for safekeeping to avoid liability and make claims when necessary.
These six rules would help you make the right investment choices to reap handsomely.