Startups struggle to raise funds due to a lack of funding, making it difficult to address difficulties, and that is where private investors come in since most people lack the option to operate their businesses using public funds or bank loans. In addition to the lengthy and unpredictable nature of the crowdfunding process, banks are very selective about who they choose to fund. The startup owners depend on private investors to relieve some of the strain on their finances.
Consequently, this article looks at who these private investors are in detail and how they finance startups.
Who are Private Investors?
Private Investors are the people or businesses who have a strong interest in investing their money in a business to support it financially, contribute to its expansion, and profit from their investments.
Private investors are an important source of startup funding for businesses. Startups seeking private investors have benefited from good financial support as well as the knowledge of industry professionals. This is because every Private Investor who invests in your company opens up a variety of opportunities and increases your exposure. As your business expands, you’ll need more capital, and finding investors to provide it to you becomes a herculean task.
Therefore, before approaching private investors, you must be aware of the following vital information about types of private investors and how to find them.
Who Are Considered Private Investors?
Private investments are people who have the potential to play a significant role in driving demand, capacity creation, increased labor productivity, new technology introduction, space for creative destruction, and job creation. This is because growth opportunities, rather than purely financial gain, are the main focus in the invested fields. Therefore, they possess long-term, responsible ownership to protect wealth.
What Can a Private Investor Do?
Therefore, to be a private investor, one must:
- Be different from institutional investors in that they are more focused on the growth opportunities that come with investing.
- Be focused on wealth creation and responsible ownership when making long-term investments.
- Contribute to the growth of the organization by investing in business concepts.
- Use growth opportunities that are aided by active management participation.
How Does a Private Investor Work?
Private investors, on average, cling on for five to eight years and during the holding period, investors create growth by actively collaborating with the management teams to enhance the investment. It could be to lay out useful strategic directions, make operational changes, or improve the performance of the company or the asset. This is particularly valid when it comes to private business investors.
Additionally, private real estate investors, for instance, might enjoy making complementary purchases. Here, creating a solid ownership structure and long-term wealth are the objectives. This is possible, particularly when the management team and equity owners collaborate to advance their shared interests.
What are the 5 types of investors?
Here are 5 types of private investors:
#1. Friends and family
Family and Friends are frequently the first investors in the private sector that startups and small businesses looking to. As family and friends already have the foundation of trust and involvement that founders typically have to build from scratch with other private investors, they are an excellent source of seed funding and startup capital for private companies.
#2. Angel investors
Angel investors are wealthy individuals who invest in startups privately with their own money, typically in the early stages. To form an investor pool, an angel group, or an angel capital association are several investors who will occasionally pool their funds with those of other investors. But keep in mind that the angel investor is using their funds, not capital that has been invested; as a result, even though they may be high net-worth individuals, they are still private investors who are considering funds that will come from their bank accounts.
#3. Venture Capital Firms
Venture capitalists are professional investors who make bets on big opportunities but often miss them. Unlike angels, they are not investing their own money.
A venture capitalist’s job is to find a relatively small number of investments to make over a seven to ten-year period. VC firms may review thousands of deals in a single year, but they can only choose a select few to pursue, typically focusing on high-growth startups.
#4. Private equity firms
Private equity (PE), in contrast to almost every other type of capital, is more often associated with growth capital than startup capital. PE is a type of investment that is typically only used by larger companies looking for a specific growth or exit strategy that isn’t possible through conventional financing.
Additionally, private equity firms are typically looking for later-stage companies that require larger sums of money, so if you are seeking initial funding, they may not be the right investor type for you.
#5. Banks
Banks also invest, but they do so in a manner distinct from that of individual investors. They lend money to people, businesses, and other entities as their “investment.” The bank’s interest rate increases the fixed monthly return on this investment. The best option for a business looking for financing through investing is to choose loans from their neighborhood banks.
How much do Private Investors charge?
The cost of seeking private investment for a startup depends on the stage of the business, the amount of money you are looking to raise, the type of investment you are seeking, and the structure of the deal, but the typical charge rate for a private investor is usually 7%-10%.
Therefore, the amount of money you are looking to raise will affect the cost of seeking private investment, and if you are only looking to raise a small amount, you may be able to do so through friends and family, but if you are looking for a large sum of money, you may need to seek out angel investors or venture capitalists.
Furthermore, angel investors and venture capitalists typically expect a higher return on their investment, making equity investments more expensive than debt financing, but can provide more growth potential.
Note that the cost of seeking private investment for a startup depends on the stage of the business, the amount of money sought, the type of investment, and the structure of the deal.
How Do Private Investors Get Paid?
They choose potential companies and offer suggestions on how to improve the ideas’ profitability. After making a long-term investment, rewards are realized. Venture capitalists and angel investors may take an equity stake or charge a fee as profit.
Additionally, like shareholders of a public company, private investors receive dividend payments as part of their returns. Dividend recapitalization is the term for the process of borrowing money to distribute dividends to private equity shareholders.
Is an Investor an Owner?
Private investors are not the company’s owners, but rather they have invested in ownership if they purchase stock in your company. The proportionate share of the company’s profits will be deducted from the return received. The initial investment sum will continue to be correlated to the overall value of the business.
What Are the 3 Types of Investors?
#1: Pre-Investor
Simply put, a pre-investor is a person who isn’t investing. Pre-investors are distinguished by a low level of financial awareness. There isn’t much consideration given to investing, and as a result, there aren’t many savings or investments to show for it. Some pre-investors participate in the company retirement plan, but this wouldn’t be the case if the human resources department hadn’t set it up.
Consequently, pre-investors live paycheck to paycheck believing their financial difficulties will be solved by the next pay increase, prioritizing consumption over savings and investment.
#2: Passive Investors
Passive investing is the most common starting point for financial security, and most financial institutions and educational services. Passive investing is the most common type of investing, with 90% of investors employing sound financial planning and saving at least 10% of earnings. Additionally, passive investing is beneficial for people with busy lives, families, jobs, outside interests, or entrepreneurs, but can be difficult due to limited time.
Passive investment strategies are accessible to the general populace but can have negative consequences as they require a working lifetime combined with discipline and regular savings contributions to achieve financial independence, and can take more risk and lower returns than experienced investors. Passive investors have no “value-added” or skill component to their expected return stream, so they depend on the market’s opportunity for investment return.
#3: Active Investor
Active investors build upon the passive investor’s foundation. By managing their wealth like a business, they advance the process. The main distinction between active and passive investors is that the former obtain value-added returns based on skill and market-based passive returns, providing two sources of return on a single investment.
Active investing is more work than passive investing but has the potential to increase returns and lower risk. It creates an investment return over market rates by exploiting inefficiencies that can be profited from in a business-like fashion.
How to Find Private Investors for Your Business
Preparation is key to finding a good private investor, including creating a business plan and conducting a market analysis to improve offerings and connect with customers.
To find a private investor for your business, you must:
- Set a budget and put together a presentation of your strategy.
- Knowing the strategy inside and out will make communicating with investors simple.
- To persuade investors to help finance your business, practice your pitch.
- Find private investors once your business plan is polished.
- Working through your personal and professional networks, start small.
- Try your local trade associations, small business community groups, and chamber of commerce.
Finally, you can look for private investors via business capital brokers. Brokers assess your business plan, build connections with financiers, and pair you with the best matches. The broker’s commission charges should be avoided because they can be expensive.
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