The Pros and Cons of Having Private Investors
According to the Small Business Administration, the average entrepreneur needs $10,000 to start a small business. Plus, if you plan to hire employees as you grow, the amount of funding you’ll probably need additional funds to afford payroll.
A key aspect of your business plan that you should examine is how you plan to finance your operations. Although a combination of self-funding and loans is common for many small business owners, you also have the option of seeking venture capital from outside investors. However, like other financing options, investor funding has its limitations.
Still, the benefits could help propel your business forward, so it’s worth considering. To help you decide whether having private investors is right for your business, we’ve compiled a list of pros and cons.
Is Having a Private Investor Right for Your Company?
1. Pro: It’s Not a Loan
While business loans can be great funding options, you’ll need to repay it regardless of if your business is successful or not. Outside investors understand and accept the risk that if your business plan fails, they can lose their money. If their investment goes south, you’re not responsible for repayment.
However, it’s important not to confuse investors with private investor loans. This is a type of financing, also known as private lending, occurs when individuals provide funds to investors in order to get a loan with private real estate. It’s an alternative to loans from banks and other financial institutions.
2. Con: It Dilutes Your Share of Earnings
In exchange for their investment, most investors expect a share of your profits. This limits your upside potential if your business becomes successful. While sharing equity in your business may not prevent you from enjoying the fruits of your labor, you’ll want to ensure that your investors don’t eat up too much of your profit margin. If they do, this private investment won’t be beneficial to you in the long run.
3. Pro: You Don’t Need a Proven Credit History
Some business lenders have strict credit and financial history requirements, which can make the application process grueling with no guarantee that you’ll be approved. In comparison, private investors are typically more concerned with the money you can make them in the future than what you’ve done in the past. Due to this, they’re willing to take on more risk than most loan providers.
4. Con: The Stakes Are Higher
Above all else, your investors are interested in making money. In exchange for taking on additional risk, they generally have higher performance requirements that can create a lot of pressure, especially if you’re not meeting them.
Before accepting outside investments from venture capitalists, you should make sure your investors’ expectations are in line with your projections and capabilities. If your goals aren’t aligned, you should look for business financing elsewhere.
5. Pro: It Gives You Access to The Investors’ Expertise
Many business investors have extensive experience running companies and may even have specialized knowledge in your industry. Because of this, they can provide you with insights that you might otherwise not have access to.
Once you find investors, you can learn from their expertise and leverage it to improve your chances of success. One Harvard Business School study found that new ventures backed by prominent angel investors experienced better outcomes than startups that didn’t receive funding.
6. Con: You May Lose Some Control
Most outside investments come with strings attached. When you have additional stakeholders in your business, you’re accountable to more people than just yourself. Your investors may insist on being part of the decision-making process or could make you seek approval before executing on a new strategy.
At a minimum, you’ll likely have to explain why you made certain business decisions. Unless your investors are willing to take a completely hands-off approach, you’ll need to feel comfortable sharing control of your business.
Conclusion: Consider Your Options Prior to Taking On Investors
Financial capital is the lifeblood of most small businesses. Indeed, 29 percent of small businesses fail because they run out of cash. While you may be tempted to take funding wherever you can find it, it’s important to weigh the costs and benefits of any major business decision before proceeding.
If you don’t want to forgo a portion of your earnings or be held accountable to others for your decisions, outside investors likely aren’t right for your business. On the other hand, access to additional expertise may be exactly what your business needs to prosper long-term.
Editor’s Note: This post was updated for accuracy and comprehensiveness in February 2021.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.