WEBLOG Houston, Texas: September 30th, 2010: For the past 10 years, I have made myself available as an angel investor for local small businesses. In all that time, only one person has come to me with anything like a sensible proposal. All other proposals have been non-starters due to a total lack of financial comprehension and all attempts at negotiating an equitable arrangement have fallen on deaf ears. I thought some comments from this side of the fence might help would-be borrowers.
1. Banks do not invest in businesses and investors are not banks.
2. Many approaches have been along the lines of "If you will invest $20,000 (or whatever sum) I'll give you 10% of the profits." Only trouble is, they aren't making any profit and the possibility that they might make a profit some time in the future is not sufficient incentive for me to give them $20,000 now.
3. Most wanted money but could not tell me in any detail what they would spend the money on. I was left suspecting it would be used to pay themselves a salary - until the money ran out.
4. One person wanted to sell me 10% of his business for $20,000. This, of course, valued his business at $200,000. He could not tell me exactly how much his business was worth and could only talk of his dreams to grow the business. No growth strategies seemed to be in place. All the hard assets that I could see (equipment) were purchased with a loan, so it looked like the business was worth nothing, although it was earning enough to pay the loans and provide a meagre income for himself and three employees.
5. Some wanted a straight loan. They couldn't get a loan from the bank and wanted me to lend them the money. They seemed to think 50% increase on the bank rate was a great offer - they offered 8% interest against the 5% interest they couldn't get at the bank. They didn't think I was taking any risk in making such a loan.
Observations:
a) When an investor puts any money at all into another person's business, he is taking on 100% risk. There is a risk that he will lose 100% of his money.
b) The business owner who has no money in the business risks very little. If the business fails, the investor loses eveything but the business owner still has his idea and can on and start another business with the same idea.
c) If an investor is going to risk so much, he will need a high rate of return to compensate for that risk. Doubling his money over 5 years is not sufficient incentive in most cases - it represents only 15% per year. Doubling in two years - 40% p.a. - is not excessive.
d) It is so obvious, in most cases, that the business owner has little understanding of money that a prudent investor would insist on controlling the money and, thereby, controlling the business.
I hope these thoughts help business owners understand how money works in the real world beyond their dreams.
