An investor contributes money to a business with the expectation of receiving a financial return. The main aim of any investor is to earn maximum profit with minimum risk. Most startups depend on investors to fund their startups. The investor’s fund will significantly support the company if the business introduces a new product or expands its operations. Investors help businesses get funded and ensure that the capital invested is correct and oriented towards either value or growth strategies. All investors are not the same; they may vary according to resources, capital styles, risk tolerance, and motivation. The investor’s quality and level of involvement determine the success or failure of a startup. So, it is necessary to understand different types of investors and learn how to choose the right one. Let’s take a quick look at the various categories of investors:
1. Personal investors:
Entrepreneurs could approach personal investors as a first resort as their family, friends, and close acquaintances. This type of investor supports startups or businesses to get off the ground. There is a limit on how much they can invest in your startup, so they might not give you much cash at once. They know and trust you the most, which is the best thing. However, you will require extensive documentation that outlines the rate of return, the amount of the investment, and ownership arrangements to assist you. Therefore, make sure to speak with a lawyer to avoid any potential obstacles.
2. Peer-to-peer lenders:
Peer-to-peer lenders are individuals or groups who provide capital to small businesses/startups through websites. Owners must apply with peer-to-peer lending companies like Prosper and Lending Club to get their desired money. Startups must create a business plan and share their financial forecasting, market research, and industry analysis. You may occasionally inquire as to how much money you have invested. Potential peer-to-peer investors will investigate the creditworthiness of the company. Once approved, the owner and the lender (a private individual) negotiate an interest rate for the investment. The lender then provides the funds to the owner.
3. Angel investors:
Angel investors are ex-founders who invest in startups or new entrepreneurs (also known as seed investors, private investors, business angels, or angel founders). Many people are familiar with them as the primary funding source and the most active type of investor. They could be wealthy business owners, executives, or business professionals. The best thing about angel investors is that they do not have to repay their funds if the business fails.
At the same time, investment is generally risky, and it should not exceed 10% of an angel investor’s portfolio or one out of every ten deals. An angel investor contributes funds in exchange for a higher rate of return (equity position and influence over management decisions). Moreover they are typically wealthy individuals who assist startups in their early stages of development and foster innovation to gain credibility and acceptance in their industry. They also provide advice to the businesses in which they invest. Through connections made by other startup founders, live pitch events, or direct online contact, you can get in touch with them. Before approaching angel investors, startups must ensure that their business is ready and has a plan.
4. Venture capitalist:
A venture capitalist (VC) is a person or company that invests in startups with long-term growth potential. Affluent investors and investment banks are examples of prominent venture capitalists or firms. They focus on growing businesses with solid business plans and high profits, so they expect some ownership and input into overall management decisions. VCs have relevant experience and connections to other investors and business leaders.
Startups may choose venture capitalists because they receive open funding as well as expert advice. They are not interested in high-risk start-ups that require a small amount of capital to get started. VCs invest in a large number of deals, say one out of every 100, whereas angels invest in one out of every ten sales. They conduct extensive due diligence on each investment, which can take up to 5 months. If you need a large cash infusion to get started, venture capitalists may be your best option.
5. Incubators and Accelerators:
Incubators are collaborative programmes that provide startups with access to funding opportunities, training, guidance, mentorship, and networks. Whereas, accelerators are program that help startups for rapid growth with financial support, training, mentorship, and networks.
Startups seek the assistance of banks to cover their small business loans. Qualifying for a bank loan is challenging for early-stage startups and businesses. Banks typically request an overall business plan that includes a detailed description of the company’s product/service, financial and management projections, and strategies for goal implementation before deciding whether to provide funding in the form of a loan. You must demonstrate your financial stability. In addition to banks and other financial institutions, you should look into loans guaranteed by the Small Business Administration (SBA). SBA loan programmes include:
- 7(a) loan: 7(a) loans meant for purchasing equipment, inventory, working capital, real estate purchasing.
- Microloans: Microloans consist of a loan amount with a maximum of $50,000 for purchasing equipment, inventory, working capital. The real estate already purchased or debts already arise does not come under this category.
- 504 loans: 504 loans are needed to expand the operations of startups say acquisition of fixed assets like land and building, real estate, modernization of existing facilities, debt refinancing.
Hopefully, you will be aware of the various types of investors available for startup funding. Every startup/company is distinct. As a result, selecting the correct type of investor is critical for your startup. Choose the best by assessing where your company stands and what is appropriate for you and your startup. Most startups fall short in this area. Worried? Don’t be! Get started with the assistance of our experts. We make sure that your new business gets off to a good start.
Checkout our blog on Viability Gap funding next.