What to Know Before Investing in Small Businesses

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Investing in a business startup may seem like a bad decision, especially because 29% of small businesses fail when they run out of capital. However, business entities at the startup phase pose a unique opportunity to expand your wealth. Small companies can give more returns than big and established companies. Nurturing and growing small businesses should be a core focus for anyone looking to build long-term strategic assets. In this piece, we will look at some important things to note before investing in small businesses.

Research is Imperative

Ideally, you should only invest in a business you have a good understanding of. An important document to request is the loss and profit statements and the marketing and business plans. Ask to see the audited accounting records of the firm for the past year, as this will help give you a clear idea of the cash flow of the company. Also, you need to review the sector the business operates in and find out the level of volatility associated with it. You should know how easily the business will scale if you invest in it.

Interview the Owners

Before you invest in a small business, you need to determine how much experience the founders have in that line of business, especially as it affects customer and personnel management. Enquire how much equity they have in the business because you don’t want to invest in a business where the founder has little financial input. Also, you may want to conduct a background check on the core staff, and if they don’t cooperate in this regard, that is a red flag.

If a small business is requesting capital investment, find out if they have a spelled-out plan on how to use the money. Also, find out if they will be requiring for than financial investment from you and also how many investors they are targetting.

Check the Financials

Currently, there are 46,000 accounting firms in the United States, and you can engage any of them to carry out a financial audit of the firm you want to invest in. A serious firm should be able to prove to the investor that their financial goals can be met when they partner with the company. If the company has been operating for a while, it should be able to prove a track record of excellent financial performance.

A Clear Structure

Buying into a company comes with some legal requirements, and you as an investor should be sure the company has considered that. A good company should have a solid business structure that allows interested parties to buy into it. Also, as an investor, will you have a say in the business decisions taken by the company? Furthermore, there should be a clear valuation of the firm so that if you are investing $50,000 at a 10% share of the company, you should be sure the company is worth at least $500,000.

Ideally, you should have a stockholder’s agreement that spells out each owner’s rights, obligations, and limitations. Also, if there is a plan for the distribution of dividends, there should be a plan of how often, how much, and what happens if that distribution can’t happen.

Integrity

Small businesses usually tend to give big returns on money invested, especially if they are well managed and funded. Understanding certain things such as the numerous types of relief you may get for business torts such as punitive damages, compensatory damages, and injunctive reliefs can help prepare you for eventualities. Also, carrying out a background check, and confirming their structural and personnel integrity, among other factors, are important before you invest.

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