In Part 3 of this multi-part series on managing your MSP’s money, we talked about dealing with the bank and finding the right bank to loan you money. However, banks aren’t the only source of funding for MSPs and other small businesses.
If you’re still in the planning stages of opening your MSP business, it may be difficult to get a bank to loan sufficient funds to a start-up. Even if your business is already established, it’s not always easy to get a loan for expansion or just to get you through a temporary cash flow crisis.That’s when you might go looking for someone else who’ll believe in you enough to risk putting money into your company.
Should you or shouldn’t you solicit investors?
Before we discuss different types of investors, there’s a question you need to consider: should you be soliciting investors at all? It’s important to understand that when someone else invests in your business, that person or company takes on an ownership interest. This is called equity financing. That means you may no longer be free to run the company as you wish. You incur an obligation to your investor(s).
One advisor writes that “taking on an equity investment is like entering into a marriage.” However, many investors are not looking for a lifetime commitment; they are more likely to be looking for a three to seven year involvement.
Types of investors
What kind of people are you looking at spending the next half a decade or so “married to” in your business life? Let’s look at the types of investors who typically help to finance a business:
- FFF: in the investment world, this stands for “friends, family and fools” – individuals (often not wealthy ones) who will either invest in return for a stake in the business, give you a loan (sometimes at low or no interest) or even outright gift you with the money you need for the business. An obvious advantage is that you probably won’t have to deal with nearly as much paperwork, may not have to provide a business plan or other documentation, and won’t generally have to go through a long, drawn-out application and approval process. The risk is that doing business with family and friends can be tricky, emotionally, resulting in misunderstandings and hurt feelings that can damage the relationship.
- Angel investors: This is a term for individuals, generally not friends or family members, who finance small businesses with their own funds or those of their own businesses or trusts. They typically invest from $25,000 to $1 million. Because they are taking a big risk, they generally expect a high return on their investments. Be aware that part of that deal may be that you will plan to go public (IPO) or be acquired by a larger company within the next several years. Despite their names, angels don’t invest out of the goodness of their hearts, but to make a profit. However, they do often take a more personal interest in the business and in you than institutional investors would, and may provide you with mentoring and guidance. Angels may invest seed money to help you start your business.
Consider whether your “angel” is an accredited investor, as defined by Regulation D, 1933 Securities Exchange Act. These are individuals who have a net worth of at least $1 million (excluding the primary residence) or income of at least $200,000 in the two previous years. Here are some tips on attracting accredited investors.
- Venture capitalists: Venture capitalists are generally investing OPM (other people’s money) rather than their own; they work for firms that do this as their business. They typically invest larger amounts of money (more than $1-1.5 million). They often invest in a large portfolio of businesses and expect a return of 25-30 percent across the entire portfolio. VCs are very discriminating, and may not even consider your business unless you’re referred to them by their trusted business contacts. They generally have a standard, methodical procedure for vetting you and your business so expect some red tape and usually it will take longer to get the money in comparison to FFF or angels. VCs are more likely to invest in businesses that are already up and running and have revenue coming in.
- Crowdfunding: A new alternative source of investment, this refers to selling small amounts of equity in the business to multiple small investors. This was only very recently made legal in the U.S. by the JOBS Act and SEC rulings are still to come before it actually goes into effect. You can read more about crowdfunding here.
- Employee Stock Ownership Plan: Companies can raise money by selling stock in the company to employees rather than outside investors.
Of course, the ultimate funding adventure is when you open up investment in your MSP to the public, by selling shares of common stock that can be traded on the stock market. That’s called “going public” and the first step is an initial public offering (IPO). And that’s what we’ll talk about in Part 5.