Getting financing for your start-up can be a crucial first step in launching your company. However, obtaining start-up financing is not always as simple as it seems. Different types of investors look for ideas that they think will succeed or align with their interests or values. This means that every investor has a different approach to buying into a business. Your company’s success hinges on finding the right buyer to assist, maintain, and expand the future of your business.
With each buyer having contrasting opinions in business planning, management, and expansion, it’s essential to find the one that fits best with your business. Familiarizing yourself with the different types of investors helps with decision-making when selling your business.
In this article, we’ll go into detail about the different investing styles and the types of investors that would suit your business.
What is a business investor?
An investor is an individual, company, fund, or group of people who invest money in the hope of someday making a profit. They use capital or the capital of others to buy securities or other assets of a business.
There are several different types of assets. These include stocks, bonds, real estate, currencies, derivatives, guarantees, loans, equity, and bonds. The investor’s goal is to maximize return (profit or interest) while lowering risk.
There are two common ways that investors generate returns through equity investment. These include:
- Private equity investment: Investors buy company shares from the company itself, the stock market, or other investors. The investor becomes a shareholder and receives a portion of the company’s profits or losses. This means that when stocks pay dividends or rise in value, the investor can earn profits.
- Debt investment: Investors borrow money from a business and expect repayment with interest over a specified period. Debt investment involves private investors, banks, or lenders and involves different kinds of debt.
Some types of investors search for low-risk opportunities that eventually produce conservative gains. Others prepare to assume significant risks to get a greater return. When purchasing ownership holdings in small businesses, private equity investors assume risks that many other investors might not want to incur. That said, let’s look at some of the risk tolerance involved in some investors’ decisions.
Styles and tolerance for risk
Source: Canva
Investors do not all behave the same way. Their risk tolerance, financial resources, personal preferences, and time frames differ. For example, some investors might favor extremely low-risk investments like certificates of deposit and specific bond instruments that will produce conservative gains. In contrast, others are more willing to take on more risk and invest in stocks, developing markets, or currencies.
Institutional investors are businesses like financial institutions or mutual funds that accumulate significant stock and other financial asset holdings. To make larger investments, they gather and pool funds from several smaller investors (individuals and businesses). As a result, institutional investors have much more market clout and influence over the markets than ordinary investors do.
Understanding the different investing styles:
Pre-investors
This is a general word for those who haven’t started investing yet. It covers friends, relatives, and close personal contacts but excludes all professional investors. These people are new to investing but are willing to back your company.
Early-stage businesses can only obtain pre-investment financing from close personal contacts. You may lack concrete evidence or any other reliable indicators that your company will be successful. However, pre-investors invest because they know, believe in, and trust you.
Passive investors
Passive investors adopt a buy-and-hold strategy that they anticipate will pay off in the long run. They restrict the amount of hands-on management over the assets they own. A passive investor will defer to the operational and financial decisions made by the management team as opposed to having an active part in the management of a firm.
By purchasing and holding securities for an extended period, passive investing tries to duplicate the return of a segment of the market or a benchmark index. Limiting trading and diversifying assets can reduce risk and costs. The foundation of passive investing is the idea that the market generates gains over the long term.
Active investors
On the other hand, active investors want to have a say in managing their funds. In a private equity setting, active investors could bring in new personnel to support management teams and assertively alter a company’s organizational structure.
Based on their knowledge and experience, active investors look for opportunities to make operational, financial, and administrative adjustments. Because of this, active investing typically carries higher risk, but when done successfully, it can also produce higher profits.
These types of investors put a lot of time and effort into financial analysis and appraisal before investing because this also raises risk exposure.
What are the different types of investors?
There are many different types of investors, all with their resources, skills, and goals. Depending on your business plan, your demand for financing, and the size of your company, you might favor one type of investor over another. Let’s look at the different investment types and the advantages and disadvantages of each type.
Incubators and accelerators
These business growth tools assist new businesses in getting on their feet. Incubators help with early-stage development, while accelerators help existing companies speed up their growth. These types of investments usually provide office space, mentorship programs, and business connections to aid businesses in improving their revenue.
While these investments offer funding opportunities and new resources, they also have time limits that could hinder your chance for growth. However, this form of investment comes at the cost of equity.
Bankers and financial institutions
Although not necessarily investors, banks and financial institutions are a great way to get the funding you need. To get a line of credit or merchant advice loan from your bank, you’ll need the following relevant documents to prove your creditworthiness.
- An in-depth business plan
- Business description
- Foreseen future opportunities
- Business proposal
- Financial objections
- Implementation plan
- Start-up description offering
That said, acquiring a bank or financial institution loan takes work. You’ll need to prove that you can repay the money you borrow by managing your debt well. It’s also important to note that most banks have high-interest rates and unforeseen account fees that could cost you.
Angel investors
Angel investors, otherwise known as entrepreneurial investors, are usually people with business experience who enjoy helping others. These investors generally invest a once-off monetary sum in exchange for shares in your company.
Angel investors consist of friends or family that want your business to succeed. Angel investors offer the best terms for your start-up because they are more interested in watching your business grow than in making money from it.
Venture capitalists
These investors lend money to businesses with strong development potential in exchange for an equity stake. A venture capitalist investment may consist of financing start-ups or small businesses that want to grow but need access to the stock market.
Venture capitalists offer a quick and scalable route to company expansion and make it easy to develop ideas into sellable products or services. There is little risk and even less legal obligation for repayments, but this comes at a cost. Investing with venture capitalists means sacrificing your structure of ownership, control, and shares.
Strategic investors
A strategic investor is an individual or business that makes investments to gain strategic advantages instead of purely financial returns.
These benefits could include first say on the company’s future development and direction and access to the technology, ideas, services, or products invested in the business. It could also include advice on the product roadmap, engineering and resources, and crucial introductions.
Investing with strategic investors means you’ll have access to better opportunities, but risks are involved. Strategic investors can limit your ability to sell your products or services to competitors. This could impact your success.
Bootstrapping
Bootstrapping is investing in your own company during the beginning stages. Without a business plan or a pitch to potential investors, investing in your own company gives you complete control of your start-up.
Bootstrapping funds new equipment, supplies, new products, and business expansion. If you’re considering bootstrapping, you can fund your business in the following few ways:
- Borrow money from a life insurance policy
- Take out a second mortgage
- Use money from your retirement account
- Establish a home equity line of credit
Bootstrapping allows you the freedom of experimenting with new products, saves you time from running after investors, and means you get to keep 100% of the equity. That said, it is a high-risk investment. With this type of investment, you risk inhibited growth, unestablished credibility, and limited funds.
Small loans
Small loans are for businesses that cannot obtain traditional financing. A lender, like a bank, offers this type of financing to business owners to help them reach their objectives. This includes investing in capital, expanding, or making upgrades.
Small business loans can take the form of a revolving line of credit or a debt-based agreement, where the borrower can use the loan as many times as necessary as long as it is repaid with interest over time. Small company loans often have high dollar amounts with low-interest rates, but that’s not without rigid requirements and a mountain of application paperwork.
Crowdfunding platforms
Crowdfunding is using modest sums of money from many people to finance your start-up business. Crowdfunding utilizes social media and funding websites to help connect you to the right investors. This investment style can boost entrepreneurship by enlarging the pool of investors beyond the usual circle of owners, relatives, and venture capitalists.
Thanks to crowdfunding platforms, many people impacted by a natural disaster, a significant medical bill, or another tragic event like a house fire have gotten financial assistance they wouldn’t have otherwise been able to access. In recent years, specific crowdfunding sites have broadened the appeal of crowdsourcing by providing a means for creative people, such as authors, singers, painters, and podcasters, to support their creative work through a reliable source of revenue.
Crowdfunding allows entrepreneurs to grow their audience while receiving the funding they need without having to sell any equity. That said, conforming to crowdfunding could damage your company’s reputation. It’s also important to note that there are fees with specific crowdfunding platforms.
Conclusion
Investors typically look for companies with particular qualities that fit their portfolios. Understanding the different investment styles and types of investors will help you find the right investor. It’s also a good idea to look at investor portfolios when screening potential investors. If you can find someone who consistently makes investments in companies like yours, the chances of attracting their investment are much higher.