If you’re asked to back a startup business, don’t invest unless the people responsible for the company have put together a business plan with projected results, based on assumptions that seem reasonable. Check with an accountant or an investment advisor to see if the projections make sense.
Here’s a quick-and-dirty rundown of considerations:
- Look for an experienced business person to run the company. Even with a great concept, a company can still fail if there’s no one who knows how to operate a business.
- Without enough capital, the business will cease to exist. If the business runs short of capital you may be asked for more, putting you in the position of throwing bad money after bad.
- If you’re offered a choice between making an equity investment or making a loan, choose equity. Either way, your money is at-risk, so you should have the upside potential of owning part of the company.
- The agreement should be formal rather than a handshake deal, specifying whether you’ll be repaid with regular interest payments, dividends from any future profits, or compensation for services rendered.
Finally, an exit strategy should be in place from the beginning. Do the founders intend to stay around and repay you from operating income? If not, do they hope for a public offering or a buyout by a larger entity? If you’re going to risk your money you should know how you might be rewarded.