Investing in a private business offers a direct way to participate in economic growth, support innovation, and potentially generate financial returns. Unlike buying shares in a publicly-traded corporation, investing in a private company allows you to back a local entrepreneur or a promising startup. This path provides an opportunity to see your capital make a tangible impact by helping a company grow. It is also a way to align your financial goals with your interest in a particular industry or desire to foster community development.
Determine Your Investor Profile
Before seeking opportunities, you must perform a self-assessment to build your investor profile. This involves a clear look at your financial situation, goals, and comfort with risk. You must determine the amount of capital you can afford to invest, which should be considered “risk capital”—funds you can lose without impacting your financial stability.
Your desired level of involvement is another component of your profile. Active investors take a hands-on role by providing mentorship or leveraging their networks, while passive investors provide capital without participating in daily operations. Your choice will depend on your available time, expertise, and interest in the business.
You must also assess your risk tolerance. Investing in a pre-revenue startup is different from funding an established, profitable business. The former presents a higher potential for loss but also a greater opportunity for returns, while the latter offers more stability but likely a more modest return.
Some investment opportunities are available only to individuals who meet specific criteria set by securities regulators. In the United States, this is the “accredited investor” designation. An individual qualifies by having a net worth over $1 million (excluding their primary residence) or an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the same expectation for the current year. Prospective investors should verify current regulations with the Securities and Exchange Commission (SEC).
Understand Investment Types
With a clear investor profile, the next step is to understand the primary ways capital is invested into a business. These methods determine your relationship with the company, your potential returns, and the level of risk you assume. The three main structures are equity, debt, and convertible notes.
Equity Investing
Equity investing is the most common form of investment in private companies. When you invest for equity, you purchase an ownership stake in the business by receiving shares of the company. The goal for an equity investor is for the company’s value to increase over time, which in turn makes your ownership percentage worth more. This form of investing carries the highest risk, but it also offers the highest potential for reward if the company is acquired or goes public.
Debt Investing
Debt investing functions much like being a bank for the business. Instead of buying ownership, you are lending money to the company, which it agrees to repay with interest over a predetermined period. This arrangement is formalized through a loan agreement that specifies the interest rate, repayment schedule, and any collateral. This method is lower risk than equity, as debt investors are paid back before equity holders in a liquidation, but your potential earnings are limited to the agreed-upon interest payments.
Convertible Note
A convertible note is a hybrid instrument that blends features of both debt and equity. It begins as a loan to the company, complete with an interest rate and a maturity date. However, it includes a provision that allows the debt to be converted into ownership equity at a later time, typically triggered by a future funding round. This structure is often used by early-stage startups to defer valuing the company, while offering the investor the downside protection of debt with the upside potential of equity.
Find Investment Opportunities
Once you understand your profile and investment types, the next stage is to actively seek out businesses needing capital. Opportunities can be found through various channels, and the right avenue often depends on your investor status and the businesses you wish to support.
- Online equity crowdfunding platforms have become an accessible entry point. Websites like StartEngine and Wefunder facilitate investments under regulations like Regulation Crowdfunding (Reg CF), allowing both accredited and non-accredited individuals to invest in startups, often with minimums as low as a few hundred dollars.
- Angel investor networks offer a more traditional path for those who meet the accredited investor criteria. These are organized groups where investors pool their capital and expertise to vet and fund startups. Joining such a group provides access to a curated deal flow and the ability to collaborate with experienced investors.
- Your local community can be a rich source of investment opportunities. Engaging with your local Chamber of Commerce or the Small Business Administration (SBA) can connect you with entrepreneurs. Attending local pitch events, business plan competitions, and entrepreneurship meetups provides a direct line of sight into emerging companies.
- Do not underestimate the power of your existing personal and professional network. Many successful investment deals originate from referrals and introductions through trusted colleagues and friends. Inform your contacts about your interest, as the founders you connect with may be within your existing circle.
Evaluate the Business
Finding a promising opportunity requires a rigorous evaluation process known as due diligence. This objective analysis of the business’s viability and potential for growth protects your capital and increases the likelihood of making a sound investment decision.
The first document to scrutinize is the business plan. A strong plan clearly articulates the problem the company solves and why its solution is superior to existing alternatives. It should detail the business model, target market, and strategies for customer acquisition, backed by realistic and well-researched projections.
An investment is often a bet on the people running the company. Assess the founders’ experience, their track record, and their passion for the business. A capable and trustworthy leadership team with relevant industry expertise is more likely to navigate the inevitable challenges of growing a business.
A deep dive into the company’s financial health is non-negotiable. Request and review the core financial statements: the income statement, balance sheet, and cash flow statement. For an established business, look for a history of revenue growth. For a startup, focus on the cash flow statement to see how the company manages its money and its “burn rate.”
Finally, analyze the market and the competitive landscape. Determine the size of the total addressable market to gauge the company’s growth potential. Identify the primary competitors and assess their strengths and weaknesses to ensure the business has a clear competitive advantage.
Finalize the Investment
After completing your due diligence and deciding to move forward, the final stage is to formalize the investment. This phase is procedural and relies on legal documentation to ensure the terms of the deal are clear and both parties are protected. Rushing through these final steps can lead to misunderstandings and future disputes.
The process typically begins with negotiating and signing a term sheet. This document outlines the primary terms and conditions of the investment, such as the valuation of the company, the amount being invested, and the rights the investor will receive. While mostly non-binding, it serves as the foundational blueprint for the definitive legal agreements that will follow.
Once the term sheet is signed, formal legal documents will be drafted to execute the transaction. Depending on the type of investment, this may include a Shareholders’ Agreement for an equity deal or a Loan Agreement for a debt deal. These documents are legally binding and detail every aspect of the investment, including ownership percentages, voting rights, and the responsibilities of both the company and the investor.
Hiring an experienced lawyer to review all legal documents before any money is transferred is a necessary step. An attorney specializing in corporate or securities law can identify unfavorable terms, clarify complex clauses, and ensure your interests are adequately protected. This provides a layer of security for your capital.