Business expansion is often the “next step” for the home business owner. Maybe you’ve taken on more projects than you can reasonably manage, or you see a market opportunity that can only be met through smart growth. If you need equipment, space, staff, or a combination of all three, then you need access to capital. You can go several routes, including tapping your private finances, bootstrapping, (where you reduce expenses as a means to free up more funds) commercial loans, or finding investors.
It’s important to have lofty growth-focused goals, but to achieve them you must understand the realities of finding capital. You might not have the funds within the business and do not want to risk your personal savings. Commercial lenders (i.e., banks) usually stay away from risky investments and they’ll demand steady payments whether your expansion is successful or a disaster. Often, a home business owner’s only avenue to raise sufficient capital is to turn to private investors. These are individuals (or groups) that are willing to take on risk and wait for larger future payouts because they believe your business expansion will pay off.
Home business owners that go the private investor route should understand the regulatory and practical issues involved with taking on investors. Consider these five tips when turning to private investors:
1. The Rules Still Apply When You Involve Family or Friends.
There is not much red tape required to sell equity in a home business to friends and family who are likely not sophisticated investors. However, there are still securities laws that come into effect even with these classes of people. It’s important to treat family and friends as regular investors, so you should transparently provide them full information about your business including its financial books and records. You also want to be clear about the risk factors involving your home business and impending expansion before they invest. It’s always good to err on the side of “full disclosure” to minimize disagreements down the line. To protect your business’ sensitive information, you should also ask family and friends to sign non-disclosure agreements (NDAs) before providing them sensitive business information.
2. Retain an Attorney.
A first step in preparing to approach private investors is to retain the services of an attorney familiar with securities laws and regulations. Before you ask anyone for a loan or to purchase an ownership interest in your home business, you need an attorney’s guidance on how you can receive investment funds and from whom. An attorney’s guidance is invaluable to prevent home business owners from making “innocent mistakes.” This isn’t the time to try to read and understand all the applicable state and federal securities laws and regulations. The liability risks to you personally and your business are just too great.
3. Investors Outside Your “Circle” Require More Formality.
Not every home business owner will have friends and family that are willing to invest in an expansion. Or they might not want to blend their personal and professional lives, and don’t want to jeopardize relationships by becoming business partners. A home business owner without these options will have to turn towards people that invest professionally., These people are called “accredited investors,” which are defined as those who meet certain criteria for assets and income and have investing experience as defined by various securities regulations. Selling equity in your company to people you’ve very likely never met before requires a level of formality and disclosure that’s well above the friends and family threshold. You’ll need to provide these potential investors with a private placement memorandum (PPM), which is a detailed document that describes your business, finances, the proposed terms, and goes deeper into the various risk factors. This formal document requires the services of a competent attorney who understands the proper structure and phrasing that is required to protect your business in the event of a possible dispute.
4. Stick to Corporate Governance Procedures.
The typical home business does not usually hold to strict corporate formalities, such as annual meetings, approved minutes and records, and various other actions that are standard practice for bigger companies. It’s likely you’ve operated for years without the need for such formality, but once you take on outside investors, your practices need to change dramatically. Corporate governance procedures are essential, as you have to give your investors a voice in the company’s operation, both due to legal obligations and the investment agreement’s terms. Complying with corporate governance procedures gives your investors a voice so they can participate in the success of the company. You not only owe this to investors, but it also gives you protection from personal liability, which is the primary reason to utilize a corporate structure.
5. Accept the New Reality and Mindset.
Adding equity owners to your company will change the dynamics of your entire business. Not just in a legal sense, but operationally as you are no longer functioning just for your own benefit. You owe everyone that purchased equity your best work, transparent communication, and loyalty. They put in the risk of their money, so they have a very reasonable expectation for a reward. And while you can remain in charge of the big decisions and generally run the company as you see fit, all of your choices should be informed by the financial interests of your investors. This obligation falls under your “fiduciary duty” which you must understand and follow at all times.
Moving a home business out of the garage is an exciting prospect. When the move requires capital investment from outside investors, it’s imperative you understand the applicable laws and regulations through the guidance of an experienced attorney who can set you on the right path for growth.
About Enterprise Counsel Group: Enterprise Counsel Group ALC (ECG) is a prominent West Coast law firm providing impeccable representation including litigation, mediation, arbitration and transactional services for a wide range of businesses and industry leaders. Driven by the values of professional competence, enthusiasm, intensity of effort and an unwavering dedication to clients’ best interests, ECG discovers and implements the most innovative, practical and cost-effective solutions in and out of the courtroom. For more information visit www.EnterpriseCounsel.com and follow ECG on LinkedIn, Facebook and Twitter.