Yes, there is a loss of control when you take on an investor. In the long-run, this may turn out to be financially beneficial for you, or it may destroy your company if the right decisions aren’t made.
Take on the wrong investor who isn’t interested in the nuances of your company or has a different vision then you do, and you are likely to lose your business.
Overview
An Investor is any person or entity that commits capital with the expectation of receiving financial returns. Should you take on Investors, their goal is to minimize risk while maximizing returns. They use their money to acquire an interest in your business in exchange for the potential for profitable returns through interest, dividends, or a share of the cash generated when the business is sold.
Investors represent equity financing. They supply funding in exchange for taking an equity position in the company. Equity financing is typically used by non-established businesses that do not have sufficient cash flow or collateral with which to secure business loans from financial institutions.
There are two types of investors:
- Passive Investors often referred to as angel investors
- Active investors or venture capitalists
Before taking on an investor, it is essential to identify what type of investor you want to have a say in your business. Whatever type you choose, they bring with them limitations and advantages that will naturally impact how you run your business after taking their money.
The benefit of passive investors is they likely live busy lives with little interest in rolling up their sleeves to help you run the business. They are likely to remain on the sidelines as long as they don’t believe you are putting the financial security of their investment at unnecessary risk.
An angel investor is likely to provide capital for a start-up or a business expansion they believe in. They are typically individuals who have cash available and are looking for opportunities to earn a higher rate of return than would be given by more traditional investments. An angel investor typically looks for a return of 25 percent or more.
Angel investors fill in the gap between the small-scale financing provided by family and friends and venture capitalists. The significant advantage of taking on angel investments is the money is much less risky than debt financing. Unlike a loan, invested capital does not have to be paid back in the event of business failure. Most angel investors understand business and take a long-term view.
The primary disadvantage of angel investors is the loss of complete control as business ownership is given up in exchange for investment money. Your angel investor will receive a portion of the profits based on your equity agreement, including a portion of the proceeds when the business is sold. Fail to keep them confident in your management of the business, and they will have a say in how the business is run. With debt financing, the lending institution take no share of the profits and has no control over your company’s operations unless you default on your loan and
Active investors work hard at making their money work for them, so they are going to be more engaged in what you are doing with the money they have invested in you. They will come in with definite expectations on how much their investment should return and when they should expect to see those returns.
The excellent news with venture capital (VC) investors is they will only invest in businesses they believe have long-term growth potential. The money they invest comes from high-net-worth investors, investment banks, and other financial institutions.
The pros of working with a VC are they can help your company grow quickly. They are active in working with their connections to accelerate their returns on their investment. For those owners that want help managing their promising business is another pro with VCs who will insert their control within the companies they invest in wherever they think they can contribute most. In the end, you will acquire more knowledge on running a business than you started out with.
The number one con for taking money from a VC is you relinquish a significant part of control over the business. This means that important marketing, sales, operations, hiring, and financial decisions will be at the discretion of the VC firm. What they believe to be in the best interest of their investment will be the path your company will take as long as they have an ownership position.
Another con of a VC is their constant need to understand what’s happening in the business. If you are ready for the constant distractions by the demands and interference of highly self-motivated investors, you will be in for a rude awakening. Yes, access to their capital removes some stress, yet your ability to dictate how you devote your time will be compromised. You are also likely to see the ideas of your investors, you, and your managers clash. Every time this happens, you lose time and effort in trying to get your priorities to carry the day. P ick the wrong VC, and you will be fighting for what you believe in, making the accomplishment of your goals even more difficult than before.
Before you take on outside investors, you must be very clear about what the investor is bringing to the deal besides money. Their money will be worth more to you if they bring expertise into the business or provide access to better supplier deals, for example. You also need to understand what the investor will be like to work with since their money is going to give them a voice on how the business operates. If you think they are likely to have conflicting ideas with your own, then you should consider going without their money.
It’s also important to know your business model for earning profits and have a comprehensive business profit plan in place. Fail to have an adequate plan for what you are going to do with an injection of capital, and you are at high risk of making some poor cash management decisions such as premature bonuses, unnecessary purchases, or the failure to lay money aside for a rainy day. Profit planning skills are essential for any business taking on investors.
The securing of any capital before you need it puts you at risk of spending other people’s money freely. Eventually, every investor will want their return on their investment, much like a lender wanting their loan repaid. When that time comes, you will either have it or you won’t. If you have it, everyone wins. If you don’t, you are in for a world of problems.