As more and more ladies came for polishes, plucks, and all-out makeovers in her converted basement salon, Rachel started dreaming of opening a cutting-edge beauty clinic in an upscale location.
She already had the skills, a long list of clients, and all the right tools. The one thing she was missing: Money. To cover the overhead costs of her expansion, Rachel — like any small business owner wishing to grow — has three options:
- She can save up enough to afford the upgrade, but that could take years
- She can take a loan, but she might not get enough for exactly what she envisions
- She can find an investor who will give her funds she needs, in exchange for a share in her business
On the surface, option No. 3 sounds like the ideal win-win. An investor is a partner who can bring various resources to your venture to help you grow faster and better. However, many entrepreneurs and amateur investors suffer from serious misconceptions about business investments. Sometimes it’s a fantastic idea, other times it’s anything but.
For Love, Not Money
There’s a well-known joke that early-stage investors are usually from the FFF – family, friends and fools. The implication is that you have to be either biased or stupid to make such a risky investment.
Of course, it’s not always foolish to invest in your relative’s new venture. In 2004, New York dentist Ed Zuckerberg gave his 20-year-old son, Mark, a little money to start a business. As a result he now owns a $60 million stake in Facebook.
Friends and family are the No. 1 source of funding for startups in the US. Approximately 38% of all new companies are bankrolled by the FFF, to the tune of $60 billion per year, according to Entrepreneur magazine.
It’s only natural that people who know and care about you will be more willing to take a chance on you. They may not really understand your industry or business model, but they do fondly remember how cute you looked in diapers. Based on the Torah value that helping someone earn their own parnasa is the highest form of charity, it’s also a big chesed.
Even if your friends and family are throwing wads of cash in your direction, proceed with caution. Make sure that you — and they — understand what’s at stake. Considering that up to 90% of small businesses fail, a loss is no remote possibility. And even if the business succeeds, they won’t see their principal returned unless they sell their share.
A rule in venture capital is that you should never invest a penny that you can’t easily afford to lose. It’s that risky. If you’re dealing with amateur investors (AKA your loved ones), consider what impact the loss may have on their finances. If they lose a chunk of petty cash, you may feel regretful; if they lose the roof over their heads, you may never forgive yourself.
Bear in mind that even if your FFF are richer than Rothschild, they may still resent you if they lose their money. Bitter feuds have erupted over token losses, even in the wealthiest families. A good guiding rule: Treat their money as carefully as you would the cash in your own wallet.
And finally, the factor that no one considers: beware the pitfalls of success. Far more strife and lawsuits result from business success than business failure. The more valuable the pie, the more touchy the question of who gets the bigger slice.
Every business deal should be sealed with a signed contract. While you and your Uncle Yankel may not get a lawyer involved in your heimish investment agreement, at the very least you must use one of the simple standard contracts available for free download.
In most cases, friends and family will be your only likely investors. For some businesses, especially in hi-tech, angel investors and venture capitalists can be an option.
Competition for funding is stiff and less than two percent of startups secure such investments, according to Entrepreneur. However, you can still be successful with the right concept and the right investor.
Dealing with the pros is a completely different experience from the FFF. They will perform extensive due diligence and risk analysis before making a decision. They will have a very firm set of expectations about what they will get in return for their investment. Very often, they will demand a say in major business decisions.
But who you are still counts most of all.“Most professional investors are focused primarily on the personal qualities of the entrepreneur and the vision, more than the numbers,” says Israel-based tech investor Jonathan Klahr, of Susquehanna Growth Equity. “You can make anything look amazing in a spreadsheet, so investors are generally aware of the limitations of the business plan.”
Keep it Lean
How can you prove to investors — whether it’s your mother or a venture capitalist — that your business is bound for success? Fact is, there’s no real way to know until you actually try it. But potential investors can get a hint of how the business will fare with the “Lean Startup” approach. The idea is to launch fast and cheap in order to test your business concept and show investors it’s viable.
Let’s say you decide to you want to start an arts and crafts center for kids, with different classes every afternoon after school. Your first step will be simply to advertise. Of course, you don’t yet have the equipment or supplies or even the location, but you don’t need to tell this to people who respond. Just take their details and tell them you be in touch with exact details. This way, before you buy your first jar of poster paint, you’ve already shown that your business will likely be profitable due to the proven demand for your service. As a result, potential investors are far more likely to take chance on you.
There are books, courses, and even entire conferences exploring the Lean Startup mode, but some of it is common sense. Even Rachel the beauty therapist understood it to some degree when she opened her first salon in her basement, thereby testing her market and model before shooting for the big-time.
Apart from making it easier to attract investors, starting off lean dramatically increases your chances of success. That translates into a dramatic decrease in the chances of you losing your investor’s money.
Whether your ideal investor is JP Morgan or your beloved Zaydie, that should be a big factor in your decision.
Four Things Investors Look For
- A Clear Path to Profits: Your business plan shows that you offer a great return on their investment
- Proven Market Demand: Demonstrate that people really want your offering
- A Dream Team: Professionals with a track record of success, with solid leadership at the helm
- Synergy: Investors experienced in your field can offer resources and contacts, as well as funds
Thanks to Mishpacha magazine for permission to reprint this column, which first appeared in Family First. Major credit goes to my Mishpacha editors Bassi Gruen and Sarah Glazer.
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