The main reason people enter into a real estate flip is with the hope of making money quickly. If done correctly, a real estate flip can provide very large profits, often upwards of the annual U.S. median salary.
These returns can be achieved in a very short period of time, and in many cases in only a matter of months.
Through repairing, renovating or remodeling a property, you will gain insight into aspects of construction.
You will start to understand the costs of materials and various plumbing and electrical repairs. You will learn how to spot big issues such as structural problems and environmental hazards like mold and asbestos.
You’ll also learn to budget for unexpected costs such as:
Building permits
Delays in construction or delivery of materials
Contractor disputes
Holding costs if the property doesn’t sell as quickly as you expected
This construction experience will help you make more money on future projects because you’ll know how to best budget a deal.
You should always do your market research before actually purchasing the property. You should talk to Realtors in the area, browse ‘for sale’ ads and look at houses that have recently sold.
This should give you a good idea of what people are looking for in the area. A modern design may be popular in one part of the country, while a traditional design is a winner in another.
This is why you must always do your research and target your renovation to your local market.
Once you put your first flipped property up for sale, you will gain even greater insight into what buyers in the area are looking for. Take notes on what they like and don’t like so you can make the necessary adjustments in your next, and hopefully even more successful, flip.
Flipping a property will help increase your knowledge of the real estate industry in general. If you are buying your first short sale or foreclosure, you will learn the ins and outs of the process as well as various financing and refinancing options available to you.
While undertaking a flip, you will create many new contacts in the industry, including:
Realtors
Attorneys
Contractors
Building inspectors
Insurance brokers and other investors
These contacts can come in handy for future investments or when working on your own personal property.
Personal Pride
Another advantage of a real estate flip is being able to see the potential in a property that few others can see. Knowing that you have the vision to create value in a home is a source of great personal pride, along with the ability to achieve financial returns that are far superior to most other investments available to the average person.
Secondary Words;
hard money investors
Private investors for real estate
private investor money
Semantic Words;
angel investors
investing your money
interest rates
real estate
private equity
business owner
credit score
venture capitalists
index funds
savings accounts
stock market
united states
short term
amounts of money
credit cards
types of investments
financial advisors
mutual funds
long term
small business
If you want to become a truly successful real estate investor, you need to learn everything you can about every aspect of the industry. So, the first step is to study the different aspects of investing in real estate. This includes knowing how to do your due diligence, the steps of buying a rental property, the drivers of property price growth, and the housing market trends that affect your investment.
Furthermore, every real estate investor needs to know how to find and analyze investment opportunities. After all, you should only buy the best investment properties that will yield profits and allow you to keep growing your real estate portfolio. If you don’t know what cap rate, cash on cash return, or rate of return mean, it’s time to start learning! Head over to our real estate investment blog to immerse yourself in real estate and understand every aspect of the game.
Step 2:
Real estate investing is about making money and, therefore, you should treat it like a business. Building a real estate investment portfolio requires planning your 4th and 5th purchase while you’re still on your 1st. Therefore, you need to establish a business plan to show you the way and keep you on track to succeed. Moreover, having a business plan enables you to factor in unforeseen scenarios you may experience as a real estate investor. This plan should include:
1. Investment Goals
What are your goals and objectives in building your real estate portfolio? Are you looking to make passive income or to be an active investor? Are you focused on generating cash flow or long-term appreciation? How many investment properties do you plan to buy until you reach financial freedom? You need to have clear answers to these questions and have SMART goals (Specific, Measurable, Achievable, Realistic, and Timely). Goals guide real estate investors in their decision-making and help them to monitor their achievements.
2. A Financial Plan
As a real estate investor, you need to know how you will finance your purchases. Do you have enough money saved for a down payment to get a mortgage loan? Did you consider other investment property financing methods like hard money or private money lenders? Your real estate portfolio also needs to include improvement costs as well as monthly operating expenses. Finally, you should include your overall financial goals in your financial plan to make sure your property investments will deliver those.
3. Investment Strategy
The next section of a real estate business plan includes a strategy to reach your financial goals. In other words: How will you turn an investment property into profits? There are plenty of ways to make money in real estate and knowing which investment strategy is best for you will help in maintaining your focus and moving forward. For example, there’s the buy-and-hold strategy, fix-and-flip strategy, buying rental properties, and wholesaling among others. Understanding these different investment strategies helps you design your path and move past your first investment property to grow your real estate portfolio relatively smoothly.
For more details, read: Developing a Real Estate Investing Business Plan for Beginner Investors
Step 3:
After you’ve armed yourself with real estate education and a business plan, you can now move on and buy your first investment property. In this step, you need to remember that your first property’s performance is vital to the success of your real estate portfolio from the very beginning and a key to unlocking more opportunity later. Choosing wisely and buying the right rental property makes buying a second property sooner possible.
Once you’ve decided on your investment strategy, you can start looking at what properties are available on the market for sale and where you want to invest. You can find the best investment properties in your city/cities of choice through our Property Finder. This investment tool uses filters to set your criteria and makes it much easier to find a profitable property quickly.
Do you have a free Mashvisor account? Use our Property Finder to find lucrative investment properties that match your criteria in a matter of minutes!
But first, here are a few tips for beginner real estate investors before buying a rental property:
Make sure you’re buying in the right location by conducting a real estate market analysis
Start small – maybe a single family house or a small multifamily apartment
Budget for all the costs that come with owning an investment property like mortgage payments, management fees, home insurance, and vacancies
Don’t make emotional decisions! Focus on building a real estate investment portfolio of positive cash flowing properties
To buy the first property for your real estate portfolio with confidence, read our 6-Step Guide: How to Buy Your First Investment Property in 2019.
Step 4:
The success of building a real estate investment portfolio from scratch depends on one simple aspect: the calculations. Rental income, cash flow, cap rate, cash on cash return, and more are all real estate data and metrics that, as mentioned, you should be familiar with and know how to calculate. These calculations are the foundation of any real estate investment as they’ll reveal whether or not it’s a good or bad one. If you don’t know how to do the math, however, you’ll need a real estate investment calculator to do that for you. In fact, this investment tool is a must for any investor looking to build a real estate portfolio!
The real estate investment calculator uses data that real estate investors provide (like the purchase price, down payment, closing costs, etc.) to calculate the profitability of the investment property in terms of the above metrics. So, instead of creating a spreadsheet for every investment property you plan to buy, this tool will give you readily calculated data in no time.
This tool is a must for building a real estate portfolio
Mashvisor’s Real Estate Investment Calculator
Another important feature of the real estate investment calculator is that it allows investors to easily find comps. This is important as it helps you compare similar investment properties to identify which one fits best in your real estate portfolio. And that’s not all. It also utilizes historical and predictive analytics to give you insights into the housing market where the rental property is located. This way, you’ll get an idea of how the market is performing to ensure investing in the right location.
Where can you find this revolutionary tool? Right here at Mashvisor, of course! Start searching for your investment property and analyze it using our calculator today.
Search for My Investment Property
Step 5:
Cash is the fuel that keeps your real estate investment running. The more accessibility you have to cash, the greater your ability to act quickly when new investment opportunities surface. There are a few ways to get cash from your first property to start acquiring more.
1. The Snowball Method
This method has worked for many investors for building a real estate portfolio from scratch and steadily over time. Here’s how this works: you take the cash flow that your rental property generates and use it to accumulate more rental properties and increase your wealth. For example, say that your rental property generates $500 in monthly cash flow. This gives you $6,000 of additional income annually. Now, say you want to buy a new property for a $25,000 down payment. If you keep saving cash flow, it’ll take you four years to buy the new property for real estate investing. Now you’ll have $1,000 in monthly cash flow ($500 from each property). With that, you can buy your third property in two years, rather than four, and so on.
2. The 1031 Exchange
When real estate investors sell properties, they pay some hefty capital gains taxes. This takes a portion of your profits that could go into buying another property. However, you can avoid paying this tax if you do a 1031 exchange. Following this strategy, you’ll have to reinvest all of the proceeds in a new investment property or a portfolio of properties of equal or higher value. So basically, the 1031 exchange allows you to build a real estate investment portfolio by trading one property for another without paying real estate taxes!
3. The BRRRR Strategy
BRRRR stands for Buy, Rehab, Rent, Refinance, and Repeat. Basically, you purchase your first investment property below market value and rehab it. The property is then rented out to generate rental income that enables you to pay the mortgage, earn profits, and build up equity over time. Then, you refinance the rental property to get your original capital back and buy a second property. As the last R suggests, you can repeat the process to buy multiple properties and build a real estate portfolio from scratch!
For more details, read: BRRRR Strategy: The Ultimate Guide for Real Estate Investors
Step 6:
As you start accumulating more investment properties, management becomes an important factor to account for. To succeed in real estate investing, you need to ensure that your investment portfolio is being cared for. You need to build a team of professionals in order to not make management an issue that may affect your profits. This allows you to manage your real estate portfolio while continuing to grow.
So, start outsourcing tasks where it makes sense. For example, hire a property management company to take over day-to-day operational tasks. Find a great CPA to help you when it comes to real estate taxes. Use Mashvisor to quickly find and analyze new investment opportunities. Have a home inspector who’ll examine investment properties for any defects or issues that may cause problems. Farming out tasks and utilizing new technology will keep your income more passive than if you were trying to do everything yourself.
Step 7:
As with any investment, putting all of your eggs in one basket comes with a risk. The housing market fluctuates, and if all of your investment properties are of one type, you’ll get a hard hit if the market drops. On the other hand, if you diversify your portfolio, your high-performing investments will cover you if the market drops. Real estate investors can diversify by:
Investing in Different Locations: Let’s say you live in Orlando, FL and you know that the housing market is hot, so you buy a single-family home rental and start making money. To diversify your real estate portfolio, plan for your next purchase to be in Tampa, for example, as it’s another profitable housing market.
Investing in Different Asset Class: The real estate market doesn’t always move as a whole. Sometimes, the entire market goes up or down, but other times, only a single asset class is impacted by a change. This is why it’s important to diversify by asset class. For example, instead of investing in just single-family home rentals, diversify by buying a multifamily apartment or investing in retail real estate, for example.
Investing in REITs: REITs are companies that pool money from investors to buy and finance large real estate investments. Investing in REITs gives you access to types of real estate that you may not have access to individually. This is also a great way to invest for passive income with minimal risks and responsibilities.
The Bottom Line
There you have it – a guide to building a real estate portfolio from scratch that you can follow today after signing up to Mashvisor! Whether you’re starting from scratch or looking to grow, we’ll help you out using the best real estate investment tools an investor can ask for. Click here to start looking for and analyzing the best investment properties in your city and neighborhood of choice!
However, in general, most will come with several added costs and fees that make the timing of a mortgage loan refinancing just as important as the decision to refinance.
The cash-out refinance can be one of the borrowers’ best options. It gives the borrower all of the benefits they are looking for from a standard refinancing, including a lower rate and potentially other beneficial modifications. With the cash-out refinance, borrowers also get cash paid out to them that can be used to pay down other high rate debt or possibly fund a large purchase. This can be particularly beneficial when rates are low, or in times of crisis, such as Covid-19, when lower payments and some extra cash can be very helpful.
Here’s how a cash-out refinance works. The borrower finds a lender willing to work with them. The lender assesses the previous loan terms, the balance needed to pay off the previous loan, and the borrower’s credit profile. The lender makes an offer based on an underwriting analysis. The borrower gets a new loan that pays off their previous one and locks them into a new monthly installment plan for the future.
With a standard refinance, the borrower would never see any cash in hand, just a decrease to their monthly payments. A cash-out refinance can possibly go as high as approximately 125% of loan to value. This means the refinance pays off what they owe and then the borrower may be eligible for up to 125% of their home’s value. The amount above and beyond the mortgage payoff is issued in cash just like a personal loan.
CONTENT LENGTH: 647 words or more.
SECONDARY KEYWORDS: MUST USE EACH OF THESE WORDS IN YOUR CONTENT TWICE (as long as it flows well.)
private real estate investors
private investors near me
SEMANTIC WORDS: STRONGLY ENCOURAGED FOR THIS PAGE’S CONTENT
financial institutions
angel investors
venture capital
net worth
real estate
venture capitalists
private investment
angel investment
small business owners
business decisions
equity investor
sources of funding
long term
business plan
investment funds
What are the different types of real estate investors?
Now that you know a little bit more about what a real estate investor is, the next step is to take a closer look at the different types of real estate investors. With that in mind, I’ve laid them out for you below. Read each of them over to get a better idea of what each distinct investment strategy entails.
REIT investor
Investing in a real estate investment trust (REIT) is the most passive form of real estate investing available. With this method, you’ll invest similarly to the way you’d invest in the stock market. Here, you’ll buy shares of a real estate investment company and receive dividends when the company pays out its profits. A publicly traded REIT will even have its shares listed and traded on major stock exchanges. However, a non-traded REIT may still be listed with the SEC, but it’s not publicly traded or it may be a private company.
The major benefit of investing in REITs is that, like stocks, anyone can do it. You don’t have to be an accredited investor or even have that much real estate experience. In this case, it’s as easy as buying and selling shares. Notably, REITs also have to pay out 90% of their income as dividends.
That said, the downside of investing in REITs is that you have very little control over what they invest in or how they’re managed. With that in mind, it’s important to do your research before investing in any particular REIT. Also, dividends from REITs are taxed as ordinary income, as opposed to a lower rate.
Buy-and-hold investor
Again, buy-and-hold investing is the classic example of real estate investing, where you buy up an investment property and rent it out for consistent monthly income. On the whole, this is a relatively active form of real estate investing. You do have to do the groundwork of marketing for a tenant, vetting all the potential applicants, and being on call to handle maintenance issues. It’s also meant to be a long-term strategy since investors tend to buy an investment property and keep it in their portfolio for multiple years.
The big benefit of following a buy-and-hold investment strategy is that you have the opportunity to achieve relatively stable returns. In this case, landlords can usually count on the same amount of rental income coming in every month. Additionally, if you hire a property management company, you’ll also have the opportunity to turn this into a more passive investment.
The major downside of this investment strategy is that it can be a lot of work for smaller returns than you might find with another method. As mentioned above, if you’re an individual investor who hasn’t hired a property management company, you have to be willing to take on landlord duties in order to receive any rental income, which can take a lot of time and effort.Fix-and-flip
investor
Then, there is fix-and-flip investing. As you might be able to guess, this is the same type of investing that you often see on HGTV. In this scenario, the investor will do their best to find a real estate deal that’s undervalued for the market. Then, they’ll fix it up and market it for resale at a much higher price. Once the buyer is found, the investor gets to keep the difference between the initial investment and the final sale price as profit.
The main benefit of this type of real estate investing is that, if you find the right investment opportunity, it has the potential for high returns. Also, it’s a short-term investment strategy, meaning you could see a return on your investment in just a few months.
That said, this is also a very active investment strategy. In this case, it’s up to you or your real estate agent to find the right real estate deal. Then, you have to figure out how to fix up the property. Here, you can often achieve better returns if you can do the work yourself. However, if you aren’t handy, you’ll have to plan to pay for labor costs in your budget. Finally, there’s also the risk that you could over-improve the property and lose money on the deal when it’s time to sell.
Wholesaling
M;On the other hand, real estate wholesalers will act as a middleman between a property owner and an end buyer. Here, the investment strategy is to find an underpriced real estate deal. Then, to quickly sell it for a higher price to an interested buyer without rehabbing it first. In this scenario, you get to keep the difference between the price you paid for the property and the price you sold it for as a profit.
In truth, this is a relatively passive investment strategy, and you have the potential to make a sizable profit. Typically, wholesalers will buy and sell a property the very same day in order to cut down on carrying costs. However, in order to make this work, you often need to have an established network of real estate contacts who can help you find interested buyers and distressed sellers.
First Bi Keyword
private real estate investors
private investors near me
SEMANTIC WORDS: STRONGLY ENCOURAGED FOR THIS PAGE’S CONTENT
financial institutions
angel investors
venture capital
net worth
real estate
venture capitalists
private investment
angel investment
small business owners
business decisions
equity investor
sources of funding
long term
business plan
investment funds
How to decide which type of real estate investing is right for you
Once you know a little bit more about each type of real estate investor, it’s important to decide which investment strategy may be the best fit for you. With that in mind, we’ve listed some of the criteria for you below. Keep reading to get a sense of which type of investing might be the best match for your lifestyle.
Active vs. passive investing
First, you have to decide whether you’re interested in active or passive investing. As the name suggests, active investing is a lot more work. However, in exchange, you often have the potential to make larger profits. In this case, you’re trading time and effort for the size of your returns. With a passive investment strategy, on the other hand, there is less to do but you may cut into some of your profits.
Active: Fix-and-flip, buy-and-hold
Passive: REITs, wholesaling
Long-term vs. short-term gains
Once you’ve decided between active and passive investing, the next question is whether you want to focus on short or long-term gains. While this is not always the case, often short-term gains take a lot more effort to realize then long-term ones.
Short-term: Fix-and-flip, wholesaling
Long-term: REITs, buy-and-hold
The four main types of private investors
a. Friends and family
Friends and family are often the first private investors that startups and small businesses turn to. They’re a great resource for seed funding and startup money, as friends and family already have that base of trust and involvement that founders usually have to build from scratch with other private investors.
b. Angel investors
Angel investors are wealthy individuals who invest in startups, usually at the early stages. Sometimes angel investors pool their money with other angel investors, forming an investor pool.
The typical angel investor is someone who’s net worth is likely in excess of $1 million or who earns over $200,000 per year. Incidentally, those look a lot like the credentials of an accredited investor.
Realize, though, that the angel investor is playing with their own money — not invested capital — so even though they may be a high net worth individual, they are still looking at money coming out of their personal bank account.
c. Venture capitalists
Contrary to popular mythology, venture capitalists are just regular people who make bets on big opportunities like anyone would in the stock market.
One way that they’re different from “regular people,” however, is the fact that they work for venture capital firms. Unlike angel investors, they are not investing their own money, but rather the money of their employer. They do everything in their power to make sure their bets pay off, but ultimately, even the best ones miss far more often than they hit.
A venture capitalist is charged with finding a relatively small number of investments (usually less than a dozen per year) to make over a seven to 10 year period. While the venture capital firm may look at thousands of deals in a given year, they can only pick a handful of deals to pursue.
d. Private equity firms
Unlike just about every other type of capital, private equity isn’t really associated with startup capital – it’s associated with growth capital. Private equity is a type of investment typically reserved for companies that have already grown to a larger size and are looking for a particular growth or exit strategy that isn’t available through traditional financing.
If you’re a startup with just an idea, you’re likely way too early for private equity. Typically private equity firms are looking for later stage companies that require much larger sums of money — usually at least $5 million — in businesses that already have some sort of assets to leverage.
How does private investment work?
How does private investment work
Each type of private investment works differently from the other types. Here is how the four most common types of private investment work.
a. Friends and family
Friends and family are a great source of early investment — but it can be a tricky relationship to navigate. It’s common for people to feel like they can be casual and personal with these types of investments because their relationships with the investors are personal. That’s a mistake.
Founders should treat investment from friends and family as a professional addition to their existing personal relationship. It’s a good idea to get a written contract stipulating the terms of the investment and also to make it clear that it’s very, very likely they won’t get their money back.
Remember: the vast majority of startups fail and while every founder works their hardest to make sure their company isn’t one of those failures, statistics are against them.
b. Angel investors
Angel investors are typically high net worth individuals who look to put relatively small amounts of money into startups, typically ranging from a few thousand dollars to as much as a million dollars.
Angels are often one of the more accessible forms of early stage capital for an entrepreneur and as such are a critical part of the equity fundraising ecosystem.
There is no definitive limit on what a single angel investor can invest, but a typical range would be from as little as $5,000 to as much as $5,000,000, although most angels tend to cap out around $500,000.
Angels may also invest incrementally, offering founders a small investment now with the opportunity to follow-on at a later date with additional investment, typically when something important happens with the business.
Getting good angel investment deal structures is all about creating a win-win situation. Once a founder gets an angel investor interested in their deal and agree on basic terms, they will need to discuss the best way to structure the investment.
Be cautiously optimistic
At this stage, many entrepreneurs get so excited that they forget to dot the i’s and cross the t’s on their deal.
It’s important that founders thoroughly review any term sheet with a lawyer to make sure they completely understand the deal structure and terms.
The best way to do this is by proposing deal structures that founders have already come up with.
The two most common seed stage angel investments
There are two primary types of seed stage angel investments: an equity stake and a convertible note.
There are other types of structures, but chances are startup founders are going to be talking about one of these instruments.
In either case, founders are deciding how much equity the investor will get for their investment. The difference between the two is when the founder makes the decision on how much equity will be decided upon.
The equity stake is simply the founder making the determination now.
The convertible note suggests that both parties agree that the valuation will be determined at some later date based on a few criteria.
Equity stake
An equity stake is when an investor exchanges their money for ownership interest in a company.
The amount of equity the investor receives will depend upon the valuation that the investor and founder agreed upon. So if the founder valued the company at $1,000,000 and the investor put in $150,000 of cash, the investor would get 15 percent of the company.
From there, equity stake can get complicated. Founders can start to issue different classes of stock, some which have voting rights or some that get paid back more quickly than others.
If a founder makes it far enough to start having conversations with those details, it pays to get a lawyer involved because the variations on those provision can be significant. Founders can’t afford to not understand what’s being proposed.
Most deals will be set up as an equity stake in exchange for cash.
Convertible note
Sometimes the investor and the entrepreneur cannot agree on exactly what valuation the company has today.
In that case, they may opt to issue a convertible note that basically lets both parties set the value of the company at a later date, usually when more outside money comes in and values the company then.
A convertible note is setup as a loan to the company. So if the investor put in $150,000 as a convertible note, it would mature (come due) at a specific date in the future, let’s say a year from now.
During that time it will likely accrue interest. At the maturity date in the future, the investor can choose to either ask to be repaid back in cash (like a loan) or convert that money back into the company as equity based on a valuation determined at that time.
Convertible notes have become more popular with angel investors as well as entrepreneurs over the years because it aligns both parties with the goal of maximizing the investment.
The term sheet
In the context of startups, a term sheet is the first formal — but non-binding — document between a startup founder and an investor.
A term sheet lays out the terms and conditions for investment. It’s used to negotiate the final terms, which are then written up in a contract.
A good term sheet aligns the interests of the investors and the founders, because that’s better for everyone involved (and the company) in the long run. A bad term sheet pits investors and founders against each other.
It’s not done until it’s done
The most common mistake first-time entrepreneurs make is thinking that a done deal is a done deal. It’s not.
Even getting a term sheet isn’t the same as finalizing the closing legal documents that the term sheet outlines.
This involves a great deal of back and forth between the attorneys from both sides and can easily take 30 to 60 days to complete if it gets done right.
It’s not unusual for this process to go over 90 days, but if it starts dragging over 120 days, the deal runs the risk of falling through.
c. Venture capitalists
A venture capital firm is usually run by a handful of partners who have raised a large sum of money from a group of limited partners (LPs) to invest on their behalf.
The LPs are typically large institutions, like a State Teachers Retirement System or a university who are using the services of the VC to help generate big returns on their money.
The partners then have a window of 7-10 years with which to make those investments, and more importantly, generate a big return.
Creating a big return in such a short span of time means that VCs must invest in deals that have a giant outcome.
These big outcomes not only provide great returns to the fund, they also help cover the losses of the high number of failures that high risk investing attracts.
A small number of investments
Although VCs have large sums of money, they typically invest that capital in a relatively small number of deals. It’s not uncommon for a VC with $100 million of capital to manage less than 30 investments in the entire lifetime of their fund.
The reason for this is that once each investment is made, the partners must personally manage that investment for up to 10 years. While money is often plentiful, the VC’s time is very limited.
With such a small number of investments to make, VCs tend to be very selective in the type of deals they do, typically placing just a few bets each year.
Regardless, they still may see thousands of entrepreneurs in a given year, making the probability that an entrepreneur will be the lucky recipient of a big check pretty small.
The most common check written by a venture capital firm is around $5 million and is considered a “Series A” investment. It’s relatively uncommon for these checks to be the first capital into a startup. Most startups begin with finding money from friends and family, then angel investors, and then a venture capital firm.
Depending on the size of the firm, VCs will write checks as little as $250,000 and as much as $100 million. The smaller checks are typically the domain of angel investors, so VCs will only go into smaller sums when they feel there is a compelling reason to get in early at a startup company.
Favored industries for venture capital
Venture capitalists also tend to migrate toward certain industries or trends that are more likely to yield a big return. That’s why it’s common see so much venture capital and angel investment activity around technology companies, because they have the potential to be a huge win.
Conversely, other types of industries may yield great businesses, but not giant returns. A landscaping business, for example, may be wildly successful and profitable, but it’s not likely to generate the massive return on investment that a VC needs to make its fund work.
The other reason VCs tend to invest in a few industries is because that is where their domain expertise is the strongest. It would be difficult for anyone to make a multi-million dollar decision on a restaurant if all they have ever known were microchips. When it comes to big dollar investing, VCs tend to go with what they know.
VCs know that for every 20 investments they make, only one will likely be a huge win. A win for a VC is either one of two outcomes – the company they invested in goes public or is sold for a large amount.
VCs need these big returns because the other 19 investments they make may be a total loss. The problem, of course, is that the VCs have no idea which of the 20 investments will be a home run, so they have to bet on companies that all have the potential to be the next Google.
Unlike a bank that takes all interested customers, VCs tend to be far more selective in who they take pitches from. Often these relationships are based on other professionals in their network, such as angel investors who have made smaller investments in the company at an early stage, or entrepreneurs whom they may have funded in the past.
VCs will expect entrepreneurs to be very buttoned up. They are writing big checks to a small number of companies, so they have the luxury of only investing in the well-prepared businesses.
While some VCs will in fact take pitches from an unsolicited source, it’s best bet to find an introduction through a credible resource. The VCs are the big leagues, so founders will want to make sure they do everything to make the most of their time in front of them.
d. Private equity firms
Private equity is a type of investment typically reserved for companies that have already grown to a larger size and are looking for a particular growth or exit strategy that isn’t available through traditional financing.
When private equity makes sense
Most startup or small businesses have little use for private equity. Technically, venture capital is considered private equity, but for the purposes of this explanation let’s leave venture capital out of it.
A startup with just an idea is likely way too early for private equity. Typically private equity firms are looking for later stage companies that require much larger sums of money, usually at least $5 million, in businesses that already have some sort of assets to leverage.
For businesses with existing revenues or assets, again usually north of a few million dollars, private equity becomes an interesting option.
Private equity is valuable to businesses that may have a strong operational profile, but don’t have the high return growth prospects of a technology startup or some other trendy investment type.
How private equity works
Private equity firms pool their money from Limited Partners (LPs), who tend to be pension funds, insurance companies, high net worth individuals, and endowments. The LPs invest in a private equity fund in order to employ a management group to seek out high yield investments on their behalf.
Unlike venture capital firms that make big early stage bets that they hope will have an enormous return when the company explodes with growth, a private equity firm bets a little less on speculative growth and a little more on demonstrated growth or opportunity.
The focus of the group is to purchase a company that they can either IPO, sell, or generate cash returns on. The private equity group is essentially betting on the fact that the asset it worth more in the future than it would be worth presently.
This may mean providing more operating cash, providing the owners with liquidity (buying the business from them) or potentially orchestrating a merger or acquisition that will generate more value.
Working with a private equity fund
There are all sorts of private equity funds, from those that do small deals at or below $5 million invested to those that manage multi-billion dollar deals. In each case, they are looking for existing assets that could be better positioned with outside capital.
Working with a private equity fund will require a great deal of preparation and diligence to say the least. At the point in which private equity gets involved, the finances of the business will be the central component, so the founder knowing the numbers inside and out will be critical since private equity is less focused on the vision and more focused on the numbers.
Advantages and disadvantages of working with private investors
Advantages and disadvantages of private investment
First it’s important to acknowledge that raising capital is a difficult, demoralizing, and long process — that sometimes ends with no payout. So before raising capital, founders should spend a good amount of time and energy asking themselves whether they really need to raise capital.
With that said, here are the advantages and disadvantages of raising the three main types of private investment that a startup would likely seek.
a. Friends and family
Advantages of working with friends and family
The biggest advantage of raising money from friends and family lies in the fact that a founder already has an established, trusting relationship with these people. That means they’re easier to get a meeting with, more inclined to say “yes,” and are more likely to be flexible with their expectations and timeline.
The structure of the investment will also likely be simpler than the structure of an investment obtained through more formal means. Founders borrowing from friends and family don’t have to worry about long, complicated applications.
Disadvantages of working with friends and family
However, despite those advantages, there are many reasons why an entrepreneur may not want to invest with friends and family members.
The number one reasons? Introducing large sums of money into a relationship that was previously entirely personal has the potential to ruin that relationship.
That’s a particularly big risk if a startup fails — as most do — and investors lose all of their investment. It’s important for founders to be very clear about the potential for loss when investment money from friends and family.
Friends and family members also may not be able to add value to a company in the same way that more formal, established investors can.
Venture capitalists, for example, typically invest in startups in fields that they are familiar with. Having that kind of knowledge on board is a huge advantage for any new company.
b. Angel investors
Advantages of working with angel investors
One big advantage of working with angel investors is the fact that they are often more willing to take a bigger risk than traditional financing institutes, like banks.
Additionally, while the angel investor is taking a bigger risk than a bank might, the founder is taking a smaller risk, as angel investments typically don’t have to be paid back if the startup fails.
As angel investors are typically experienced business people with many years of success already behind them, they bring a lot of knowledge to a startup that can boost the speed of growth.
Many startup founders are learning everything from scratch, so having that kind of knowledge on the team is a huge advantage.
Disadvantages of working with angel investors
The primary disadvantage of working with angel investors is that founders give up some control of their company when they take on this type of private investment.
Angel investors are purchasing a stake in the startup and will expect a certain amount of involvement and say as the company moves forward.
The exact details of how much say the angel investor gets in exchange for their investment should be outlined in the term sheet.
c. Venture capitalists
Advantages of working with venture capitalists
Similar to angel investors, venture capitalists also come to the table with a lot of business and institutional knowledge.
They’re also well-connected with other businesses that may help a new startup, professionals that a startup might want to take on, and — obviously — other investors.
Disadvantages of working with venture capitalists
Also similar to angel investors, part of what venture capitalists want in return for their investment is equity in a startup.
That means that a founder gives up part of their ownership when they bring on venture capital.
Depending on the deal, a VC may even end up with a majority share — more than 50 percent ownerships — of a startup. That means the founder or founders essentially lose management control of their company.