It is very common for startups to use investors whether it is through angels or VCs to help build and grow their business. But, eventually, it can get to the point where the business does not grow and you become one of the 50% of startups that fail. So what does this mean to the generous investors who put money behind your big idea?
As bold as it sounds, assuming that you are working with a professional investor, you do not necessarily owe them anything. Investors will typically understand the potential risks and, whilst not getting any return is incredibly frustrating, this is one of the potential outcomes of investing in high-risk and high-return ventures.
What happens to an investor’s money if your business fails?
Unless there was some sort of fraud, or if your investor snuck a term into your investment contract that changes the terms of the venture, professional investors will accept that the money they invested is most likely gone.
For a professional investor, the investment in your business is simply another part of their portfolio strategy. Every early-stage investor expects a portion of their investments to fail, a portion to have middling performance, and a smaller portion to make them a lot of money.
Therefore, if you take the decision to start your own business and are lucky enough to have an investor who believes in you and wants to put money into the business, you should not be worrying about what happens to their money afterwards. Your number one priority should be the growth and success of your business.
The one exception to this rule is for people who cannot afford to lose the money they put in. This is why you should always highlight the potential risks of an investment as well as the potential upsides, and refrain from accepting investment of large sums from a friend or family member.
So where does the investor stand on getting their lost funds?
“Once the business decides to fold,” explains Ben Sweiry of fintech startup, DimeAlley. “You start to liquidate the business.”
“This means selling off any assets or anything tangible or intangible that can turn some kind of income to pay back investors. If you have stock, inventory, equipment, property, computers or even uniforms - anything that can be recovered will typically be given back to investors.”
“This may end up only being a tiny amount of money, but it is a typical approach to recovering any losses.”
What Are The Pros And Cons Of Taking On An Investor?
Pros Of Taking On An Investor
1. Investors understand the risk and are more concerned about growth than repayment
Being eligible for a small-business loan typically entails hopping through a few hoops — challenges you might not be faced with while dealing with an investor. This is because such investors are usually experienced in the field and understand the level of involved risk and are at ease with taking it on.Even if the bank agrees to offer you the funds, they might restrict the quantity you’re able to borrow to curb the possibility of their loss.
2. An investment is not a loan
If you take out a business loan, your bank will expect you to repay it, irrespective of whether the company actually succeeds. Alternatively, with an investor, they’ll offer you the capital required, and in exchange, they receive an ownership stake in your company.
If the startup takes off, you’ll both reap the financial rewards. If your company falls flat, on the other hand, an angel investor won’t expect you to pay back the offered funds. In fact, schemes such as SEIS and EIS, are beneficial for investors because of the tax breaks involved, so it can be more cost-effective to invest in other businesses rather than pay your money straight to the taxman.
Cons Of Taking On An Investor
1. You’ll likely have to hand over equity in return.
Though you aren’t officially obligated to pay back your investor the capital they offer, as you hand equity over in your business as a portion of the deal, you essentially are giving away a portion of your future net earnings. The percentage of ownership the investor requests usually depends on how much they are investing.
2. You probably won’t have 100% control over your business decisions.
It is more likely that the investor is going to want to take a part in making decisions that affect your organisation’s outcome. Even if they give you control, you will still be accountable for explaining the reasons behind some of your decisions.
