So a question popped up on my Facebook updates recently from someone in a Facebook group that I was also in. This person has a website making $500/mth and was approached by his friend who wanted to invest into his business. His friend wanted 50% of the profits with an investment of $4000 from the sixth month of the capital injection. Do you think it was a good deal?
Some of you may think it is, some of you may think it is not. Whenever a deal is agreed upon, and the every one in the party is happy with it, then it is not a bad deal. However, if you are educated in this area of financing of your business, you will understand it is a terrible idea. Allow me to explain.
Funding Your Business
It is always a good idea to have more funds flowing into your business so that you can grow it faster. More money allows you to grow new sales channels, markets or allow you to systemise and automate your business better. When it comes to funding your business, there are 2 ways.
Loans, Debt or Bonds
They all mean the same thing. You are essentially borrowing money from someone. You will have to make the capital and interest repayment timely to not incur any late fees or interest charges and once everything is paid back in full, there is nothing to pay out anymore. Interest, repayment terms and period can vary. Some loans are structure in a way that only the capital amount needs to be repaid until the last repayment includes the interest, or it can also be a one lump sum repayment at the end of the loan term. However, I recommend when working in eCommerce businesses that you take a loan of at least 12 months, with the repayment starting only at least at the sixth month of the loan. This way you will be able to fully utilise the capital and by the sixth month, you should already start to reap the rewards of the additional funds invested in your business and repaying will not be a problem.
Equity is the most important asset you have in your business and you should never give it away freely, especially in exchange for money only. Money is everywhere, and when you have a surefire way to be making money, people always want to invest in you. When you sell your equity, you are selling part of your business away, and that includes control over your business. I personally only give away equity in exchange for network or value-added skilled labour. I only give away equity if the person who wants it is able to provide me access to wholesale buyers or distributors and retailers, and he or she needs to actually help to broker the deal, or if the person has a skill that is valuable to my business and is willing to actively work in the business. The only benefit of trading equity for capital is that you do not owe the investor any money, but instead pay him out from your profits instead.
Why is the deal from his friend so terrible?
If you have a good credit score, you can easily get a personal loan at less than 4% per annum (as of 29 July 2019). At 4% per annum, the interest is only $160. However, if this person were to accept the equity financing from his friend, he will be paying out at least $3000 per year based on his current profits. Now do you see why it is such a terrible idea?
I believe his friend genuinely wants to help him and in exchange also benefit from the growth of his business. However, because his friend does not understand what is happening out there in the market of financing as well which is why we have this problem. Once all parties have agreed to the deal, there is no turning back. What will happen later on in the business is that this person will feel bitter, and he may lose the friendship with his friend. As all of his effort he put into his business, he now gets half of the profits, he will start to feel unfair, while there is no chance of fighting the terms, he may loses his desire to continue working on the business and this income source is now totally lost. Instead of making $500 a month, he now makes nothing because he agreed to a deal without doing any due diligence.
This could have happened to you as well if you did not read today’s blog post. The problem with many small business owners is that they are good at running their businesses, but when it comes to anything else, they are completely clueless. which is why others could take advantage of you easily if you do not have this basic knowledge of funding.
Most people aren’t out to cheat you especially when they are your close friends or family members. In fact they may even feel that they are helping you, and when you try to back out from the deal, they feel that you have cheated them instead because you originally agreed to the terms but now wants to break those agreements, and that you do not appreciate that they were trying to help you in the first place.
By being more knowledgeable and treating close friends and family members similarly to how you will structure a deal with someone you do not know well, you will be able to explain clearly to them to understand, avoid any mismatch in expectations and ultimately not affect your relationships and your business.
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