Wednesday, May 11, 2016

5 Things to Know Before Investing in a Small Business



With the economy steadily recovering after the great recession, small businesses are experiencing a renaissance. While that's great for innovation, it can also be difficult to weed out the good business opportunities from the bad ones. 

With that in mind, this guide is designed to help new investors figure out what the most important factors are in making a business decision. 

Is the Business Idea Sustainable?


With the app craze currently taking Silicon Valley by storm, it's easy to get caught up in trend markets. Unfortunately, trends disappear as quickly as they come, and it can be difficult for a business to establish itself in time to truly capitalize on them. 


If you're considering investing in such a market, it might be a good idea to look at comparable businesses and see how long it took for them to establish themselves. 

Research the Structure


It's no secret that small businesses can be a risky prospect for investors. The Small Business Administration estimates that roughly fifty percent of all new small businesses fail within their first year. 

While investing early can certainly be rewarding, it also pays to understand exactly how the business plans to turn a profit. Going back to the restaurant example, if you plan to invest in a friend or relative's restaurant idea, make sure you've taken the necessary legal steps to make any deal official. 

Social bonds may be strong, but a legally binding contract is even stronger. 

Returns


Assuming the business is successful, when will you see returns? Investors that have a specific amount of time in mind before they expect to be paid should consider investing via a loan instead. 

Know the Operating Costs


One of the most important factors to consider when investing in a business is how much money it costs to maintain on a daily basis. For small businesses that are just starting out, it's also important to consider how money is being spent to establish the brand. 

For example, if a restaurant is spending money on extravagant furniture and furnishings, instead of cutting costs through suppliers like Budget Restaurant Supply, this should be a red flag for investors. 

Exit Strategy


Even if the business is successful, it's not uncommon for investors to have to wait several years before they can start seeing a return on their investment. 


Not only should an investor have an official exit strategy laid out in their investment, they should also expect to not see any kind of reliable returns for at least five years. If that's too long, then it might be best to consider holding off on the investment.

While this is by no means an exhaustive list of everything an investor should consider, it should serve as an effective baseline from which to study additional details further. 

With these five tips, you should be familiar with some of the most common failures of novice investors, and be able to tell the difference between a good prospective startup and a bad one.

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