As your wellness business grows, you’ll probably need additional cash to get to the next level. One way to raise capital is to seek investors and sell them partial ownership of your business in exchange for their investment.
In this article, we review the fundamentals of finding investors for your business. This is a demanding and potentially complex process, so give us a call and let us help if you’re navigating these waters.
As you search out investors – whether it’s Uncle Joe or a venture capital fund – consult an attorney with expertise in corporate formation and capital structure – the legal terms and conditions that govern investment in your business. The Securities and Exchange Commission, for example, requires that angels must meet the guidelines for “sophisticated investors.”
You’ll also want financial and business advice to prepare at least a private placement memorandum that lays out the rights of the investor and describes plans for the future of the business and the risks associated with the investment.
Further documentation and regulatory filings may be legally necessary depending mainly upon the number of investors, their sophistication as defined by the Securities & Exchange Commission, and the amount invested.
How equity investment works
Investors who contribute cash to your business receive an ownership interest in your business in return.
Let’s say your business is currently worth $100 and you own 100% of it.
You receive $25 from a new investor. Your business is now worth $125.
However, you no longer own 100% of it. Now you own only 80% (100/125) and your new investor owns 20% (25/125):
Four major types of private investors
New businesses typically start with an investment by their owner. They then seek additional capital from family and friends, “angel” investors, and potentially venture capital funds or other business development funds.
Family and friends are exactly that – people who have a close personal relationship with you. Angels are people who are less close to you than friends and family and who periodically put money at risk in other people’s businesses. Think of them as investors who are two steps away from you, whereas family and friends are only one step away. However, angels are typically not full-time professional investors.
For many wellness businesses, family, friends and angels provide all the outside capital they need.
The amounts provided in the chart give you a sense of how much cash is typically available from these investors. However, the specifics of each situation vary. Your brother and his wife, for example, may be part of a physician group that’s prepared to invest $500,000 in your wellness center. In that case, the lines between “family and friends” and “angel” would be blurred. Or you might find that your best source of capital is many angel investments of only $1,000 rather than a couple of larger angel investments.
Businesses that outgrow the investment capability of these sources will often then tap into venture capital funds or other business development funds. If they outgrow these investors, several options exist for finding additional funds, ranging from acquisition by a larger company to selling stock to the general public.
Again, each situation is unique – but this description gives you an overview of the major sources of investment for most businesses.
When you’re first starting your business
Entrepreneurs can tap a variety of sources for cash:
- Your personal checking and savings accounts
- Taxable investment accounts, like mutual fund investments
- Retirement accounts like 401(k) and IRA accounts
- Cash value of whole life insurance policies
- Severance pay when you leave a job
- Personal assets, like cars or electronic equipment
- Inheritance or trust fund
- Equity in your home
During the early days, you — or perhaps you plus a couple of other folks – are generally the sole owners of the business. In exchange for contributing all the assets of the business, you own 100% of the business. You’re also entitled to 100% of the financial upside as it prospers. Of course, you’ve also got 100% of the risk when your business hits bumps in the road.
If your reaction to this list is “Wait…I don’t want to put MY resources at risk!”, imagine how an outside lender or investor is going to feel. Investors expect business owners to have “skin in the game.” In fact, they expect and often require a certain level of financial investment by the owner. It’s usually not realistic to expect to provide only “sweat equity”.
As you start to expand
Family and friends can also provide cash, usually as either a gift or a loan, often with below-market interest rates. Or they may provide cash in exchange for partial ownership. You need to document these arrangements in writing. First, you and they need the records for tax purposes. Second, the Securities & Exchange Commission imposes documentation requirements which vary depending upon the number of investors, their level of sophistication, and the amounts invested. And third, it reduces the likelihood of mixed signals. More than one entrepreneur has been surprised to discover that Uncle Joe actually thought he was loaning them $10,000 — not giving them $10,000 outright.
You and your attorney can generally get the paperwork in place within a couple of weeks to a couple of months, mainly depending on the complexity of the giver’s tax situation.
While it can be awkward to approach family and friends as potential investors, they’re often willing to agree to extremely favorable terms and conditions that you would never come close to matching with an investor who doesn’t know you extremely well. They’ll often be willing to offer below-market interest rates, for example, or extended payback periods. And they usually want little if any involvement in the actual business – usually not the case with outside investors.
Once you’ve established a successful track record
“Angel” investors are the next logical source of funding for many wellness businesses. They usually have more funds available than family and friends do, so they bridge the gap between the high-risk early stages of a business and its later, more stable stages when it can attract larger sums from professional investors.
They’re often open to investing in relatively new businesses or smaller businesses. And they’ll often be ready to take an active management role. In fact, they may insist on it. That role may be paid or unpaid. Access to their expertise can be incredibly valuable for the entrepreneur.
Like any investor, most angels are hoping for a better return from their investment in your business than they might get elsewhere.
However — unlike professional investors — their goals usually go beyond the strictly financial. Angel investors in the health and wellness arena are passionate about advancing technology in a particular area, improving community health, or making a difference in people’s lives.
You need to have your financial story together when you start looking for angel investors. While they’ll be passionate about your wellness concept, they’re usually very business-savvy. If you can’t explain the financial performance of your business, and spell out what you’re going to do with their investment, you’ll be in trouble.
You’ll also want to consult an attorney with expertise in corporate formation and capital structure (that’s a term that refers to the terms and conditions that govern investment in your business). The Securities and Exchange Commission, for example, requires that angels must meet the guidelines for “sophisticated investors.”
If you have regional or national expansion plans
Your business may need more capital than your angel investors can provide. Venture capital — “VC” — funds are pools of money raised from wealthy individuals and institutions like pension funds. Fulltime professional investors run VC funds, and their sole priority is generally to achieve the highest possible financial return on their investments. Doing good, benefiting the community, and improving the lives of individuals is usually completely irrelevant for venture capitalists, although some funds do specialize in socially-conscious investments.
Most VC funds have between $50 million and $500 million available in a single fund. They split these funds among multiple investments, usually targeting a 25% or higher return on average across all of those investments. They usually realize that return when they sell an investment to another fund or to a corporation, or when the investment is converted into a publicly-traded corporation.
These investors normally avoid new businesses, and typically don’t invest amounts under $1 million. Investment guidelines do vary from firm to firm, however. Some smaller funds may be willing to make a smaller investment (perhaps in the $500,000 range, for example). And some funds will invest in the early years of a new business as well.