Should I Invest in My Friend's Business?
Have you ever had a friend approach you about investing in a start-up business that he’s involved in…and he’s really excited about? You’ve heard the speech… “I’m not at liberty to divulge any details, but the idea is brilliant and it can’t miss!”
Well, first of all, how do you know it can’t miss? Because of all the strong feelings of the friend that just told you so?
Well business success is never the result of one single good idea. Those actually are a dime a dozen. Business success is about good ideas…plus strategy, plus execution, plus management, plus a little bit of luck which never hurts.
So, here are a few things to think about before you invest a dime in a start-up business:
Are you an investor or simply self-employed? It’s one thing to invest in your own business and quite another to be an investor. If you invest in your own business, then you’re self-employed. And this is the business which pays you a salary and from which you make your day to day living. Investing in your business, or being self-employed, certainly carries a level of risk, but typically not the same risk as investing in someone else’s business (or their idea for a business).
If you’re, for example, a plumber, and you’re going to have to buy equipment with which to ply your trade. But if you know what you’re doing, and you’ve got a few customers, then it’s unlikely that any investment that you’re going to make is going to be flushed down the toilet (Yeah, I’m sorry, I had to do that).
On the other hand, investing in someone else’s start-up business or idea is something in which you have very little knowledge or really any control. Your risk is likely far higher.
What’s the track record? Is the key person (or people) responsible for the success of the potential business experienced in start-ups, or is this their first time? It’s possible to have a great idea and a lousy business. I’d rather see a boring idea run as an excellent business.
Who else is doing this? Do you know others who are investors in this business? Does anyone in this deal have a track record of investing in successful start-ups? If so, ask that person how many times their investments have turned out well, how many times have they ended up worthless. Because the next thing to consider is…
Are you willing to lose all your money? Now, that’s not exactly the positive thinking that most people want to hear at the front end of an exciting new venture, but it’s a question every investor has to ask. No one wants to lose a dime, but if you lost 100% of the money that you invest, would it change your life?
Is your friendship worth it? Now, this is directly connected to the “lose all your money” question I just stated. Soured business deals can ruin friendships, especially when it comes time to spreading around the blame for the failure. Are you willing to take the risk with this friendship? Can it survive the loss?
Now, what about business forms? The so called LLC (or the limited liability company) is the most common form offering some protections against getting sued. You’ll want to visit with your attorney about things like that.
And also another consideration is investing say your IRA money in a start-up which is probably not really even an option unless you find a very cooperative IRA trustee that would help you set up something called a self-directed IRA. And that’s not exactly cheap.
So, really I’m less concerned about the way that you make this investment (like in an LLC or in an IRA) than why.
For sure, don’t invest a dime you can’t afford to lose.
Because sometimes a ground floor opportunity can be a grave.
Offering you Wisdom on Wealth, I’m Byron Moore.
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