Even if you’ve never started a company before, you’re likely aware of how expensive business ventures can be.
You hear about companies X, Y, and Z raising round after round of financing without even a semblance of profit. Who’s willing to fund these startups and small businesses to the tune of tens or even hundreds of millions of dollars without the certainty of return?
Knowing how to find private investors for business is essential and something serial entrepreneurs innately understand. But if this is your first time considering a fundraising strategy, you’ll want to understand why private investors exist, what the various types are, and how you can find and connect with them.
What is a Private Investor?
Unlike pure public equity investors, private investors participate in funding private companies. These companies are not subject to the requirements of a publicly traded company and are usually smaller, more agile, and can offer an enormous return on investment if successful.
Private investors also seek returns through the lending of funds in the form of debt to finance small businesses, real estate, and more.
Why Businesses Need Private Investors
There are two ways your business can be funded: either out of your pocket or out of someone else’s pocket. Although facetious to say, it’s true that businesses are either bootstrapped or borrowed.
Bootstrapping is when a company does not take on any outside capital and relies entirely on the founding team and business operations to finance the company.
It’s possible, although not typical, for a company to launch into profitability from day one. Most often, startups require large amounts of capital to reach the scale — and subsequent economies of scale — needed to become profitable.
Businesses that lack the funds to re-invest and grow are doomed to remain stagnant or fail, which is why businesses usually need private investors. These private investors provide adequate capital to finance the initiatives and growth goals of the company.
Types of Private Investors
Friends and Family
Most entrepreneurs and business owners will naturally offer their friends and family the opportunity to invest in their company. In many cases, the friends and family invest solely on the merits of the entrepreneur — they invest in the person more than the business.
The drawback of this form of private investor is that, in most situations, friends and family are not wealthy, sophisticated investors with long time-horizons, adequate risk tolerance, or domain expertise. If the company shows any sign of weakness, your less-temperamental family members might come knocking on your door.
If the company fails, which is the most probable outcome with 90% of startups eventually failing, the lost investment could be non-trivial in the lives of your friends and family. Given that they are likely non-accredited, this could lead to some legal concerns and will definitely lead to some awkward family reunions.
Small Business Loans
More than $644 billion in small businesses loans (less than $1 million loans) remain outstanding. As you can see, many small businesses rely on debt as a method to finance business operations and growth.
The benefit of taking on debt in the form of business loans is that you do not give up any equity ownership of the business and only pay your agreed upon interest rate. Another benefit of lenders versus traditional investors is that they remain hands-off and let you operate your business as long as the debt is being serviced.
The downside to business loans is that you must have sufficient cash flows to service that debt. Businesses that build an aggressive debt-to-equity ratio are more likely to fall into bankruptcy if their business model is disrupted at all.
Angel investors are wealthy individual accredited investors typically with domain interest, expertise, and conviction enough to invest their own money in risky, early-stage startups. Although some angels invest in idea-stage companies, the average pre-money valuation for angel-backed companies is $6.5 million in 2020.
Here are a few strategies for connecting with angel investors:
- Local Meetup events in tech, investing, or a domain relevant to your business.
- Accelerators and incubators with a demo day.
- EquityNet’s network of angel investors.
In many cases, angel investors come from successful backgrounds as operators and founders, which enables them to provide actionable insights on strategy and growth. They are also likely very passionate about the field they invest in, which could be a downside if they are emotionally tied to the company, it could become a source of friction between the investor and founders.
In the hierarchy of private investors, venture capitalists are next in ascending order. VC firms are groups of institutional investors, funded by a number of limited partners that entrust the VCs to source deals, make investments, and subsequently return multiples on the fund.
VCs typically invest in later-stage startups when the company has proven early signs of product market fit, compounding growth, and a more clearly defined path to success. VCs are definitely more sophisticated investors and therefore will almost certainly want to see a product and track record before investing.
If venture capital is a viable option for your business — meaning the only thing holding you back from scaling to billions of dollars in revenue is financing — you will likely need to source introductions from your network. VCs are rarely receptive to cold emails and pitches; it’s consistently recommended that the best way to reach them is through a warm introduction.
Here is a strategy for getting a warm introduction to your VC of choice:
- Find a venture firm that invests in your industry and has made complementary investments (i.e., non-competitive but related to your business).
- Reach out to the CEO of a company with a complementary investment and ask about their experience working with the VC.
- After building rapport with the CEO, ask for a warm introduction to the VC.
Although venture capital can sometimes fall under the umbrella of private equity, most people tend to think of them very differently. Frequently, private equity deals are more activist in nature, and more likely to aggressively change up the management team and cut nonessential jobs.
Private equity (PE) firms have high net worth individuals as limited partners and are more interested in squeezing real returns out of the businesses they own than simply seeing returns on paper in the form of business valuations or waiting for a liquidity event (i.e., IPO, acquisition, etc.).
Private equity firms are notorious for pursuing strategies like leveraged buyouts (LBOs) to gain ownership and control of companies, make deep cuts and changes, and rebuild a stronger, more profitable business.
LBOs occur when a private equity firm purchases a company with debt using the purchasee’s assets as collateral for the loan.
Since the JOBS Act initially began relaxing SEC restrictions on the use of crowdfunding to raise capital for business, many entrepreneurs have used this tool to find investors. Whether accredited ($1+ million net worth excluding primary residence or $200,000 per year in income) or non-accredited investors, crowdfunding opens the floodgates of potential investors.
While the level of business sophistication, disclosures, and restrictions apply at different funding levels, you can essentially use crowdfunding to raise nearly any amount of money. The hoops you’ll have to jump through to successfully crowdfund will depend on which section of the JOBS Act you plan to oblige.
For example, raising on EquityNet means you are planning to raise under Title II of the JOBS Act and only from accredited investors. We discuss the various sections of the JOBS Act in our piece on equity crowdfunding.
Benefits of Private Investors
There are many benefits to taking on private investment, including runway, growth, secondary, and more, we’ll cover them briefly below.
If your business is running into cash flow constraints, product development issues, or another problem that is depleting your bank accounts and putting you at risk of bankruptcy, private investors might be your only hope of survival.
An infusion of capital could mean the difference between life or death of the company and at least gives the team more time to solve their problems and get back to sustainable levels.
Even if a business’s profit margins are extremely healthy and the team reinvests a substantial portion of profits back into the business, investment might be needed to achieve hypergrowth.
Scaling up your company’s footprint is expensive, from hiring key talent to increased marketing expenses, strategic acquisitions, leasing additional space, purchasing new equipment, and more. Not to mention, the incumbents of your industry can and will do everything possible to outcompete you. This is why some in the industry advocate for a “war chest” of cash to grow.
Another benefit of bringing on additional investors is secondary, where the private investors purchase shares of privately held companies in exchange for the shares held by existing investors or founders.
This is particularly helpful for entrepreneurs who have a large portion of their net worth tied to a single company. In many cases, these founders and early hires will want to take some risk off the table through a liquidity event. Bringing on secondary investors helps achieve this goal.
Strategies to Find Private Investors For Business
1. Incubators and Accelerators
Incubators, accelerators, and startup studios provide young companies with an ecosystem of support and resources to have the best chances of success.
Many incubators and accelerator programs offer an initial investment, and while many do take a percentage of equity, they provide additional value with a network of like-minded entrepreneurs, mentors, investors, and more.
In most cases, startups will have the length of the program to make progress towards their goal and by demo day, be prepared to demonstrate what they’ve built and pitch other investors. These investors can then decide whether or not to conduct diligence and follow through with an investment.
2. Networking and Referrals
While some investors have business development teams to source deals, many private investors depend heavily on their existing network for dealflow. So much so, in fact, that many successful investors are not receptive to cold introductions and prefer to be introduced to a potential deal through one of their existing investments or another investor they trust.
This is why it’s important to leverage your network of friends, family, colleagues, and even acquaintances for potential connections with investors. Use LinkedIn, Twitter, and other social networking sites to research investors and see if there are any mutual connections in your network to draw from.
It’s worth mentioning that at EquityNet, an equity crowdfunding site (a source of private funding we will cover next) we’ve built a tool called Crowdcast to easily integrate the social sharing aspect needed to connect with private investors.
3. Crowdfunding Sites
Another strategy for finding private investors is to use equity crowdfunding sites. Crowdfunding has emerged as a viable alternative to the more traditional fundraising strategies we’ve discussed in this article.
Depending on what type of equity crowdfunding campaign you pursue, you could raise upwards of $1 million, $20 million, $50 million, and more, from accredited and non-accredited investors — or both.
In the past, fundraising has occurred linearly; Entrepreneurs would pitch investors one at a time. Equity crowdfunding sites now provide the ability to do the work once and leverage a network of investors exponentially.
Go Forth and Fundraise
By now you should understand that there is no one-size-fits-all investor out there. Investors are like entrepreneurs themselves — they serve their niche with their expertise and check size.
If you’re raising capital to take your business to the next level, we advocate you consider equity crowdfunding before pursuing the more traditional avenues of the private funding market. The benefits of crowdfunding clearly outweigh the disadvantages.
EquityNet, for example, has spent the last 15 years helping entrepreneurs raise more than $600 million through business crowdfunding. Sign up now to take advantage of EquityNet’s patented funding platform and to connect with more than 20,000 accredited investors.