Finding capital is one of the most difficult obstacles budding entrepreneurs face. Applying for loans and grants can be exhausting, and the money is often limited.
Therefore, business owners often seek capital from private investors to get their venture off the ground or to reach the next level.
Though entrepreneurs can dip into their own wallets — almost 8 in 10 used their savings to get up and running — external funding can super-boost your growth. A private investor diversifies your funding source, reduces personal strain, and does not require repayment like business loans.
What Are Private Investors?
Private investors are individuals and organizations that invest their own money into a business. These investors hope to receive a return on their investment by enabling a company’s growth.
There are many types of private investors — for example, both your cousin and a multimillionaire venture capitalist could fall under the private investor umbrella.
“Private investors are more flexible and give you faster access to capital,” says Diane Prince, creator of entrepreneurship blog Founders Go Here. Through private investment, founders can get started more easily because they can ask people they have in their network for funding.
Types of Private Investors
Friends and Family
About 22% of founders receive funds from friends and family. And unlike other types of private investors, these people already know and trust you. If you feel strongly about your startup, ask your inner circle if they want to invest in your venture.
However, mixing relationships with business can be tricky, so make sure you outline the terms of the investment and set up a formal contract like you would with any other investor.
Angel investors are wealthy individuals who typically invest in early stage startups in exchange for ownership equity. Unlike other investors, angels don’t need approval from the SEC to invest. However, they take on significant personal risks because they are relying on their own money.
Several platforms, including AngelList, match startups to prospective angel investors. You can also find angels on social media platforms, especially LinkedIn and Twitter, by posting about your startup goals on your page and in community groups.
Explore networking events on Facebook and LinkedIn, and you could meet your angel in person. An angel investor could even come from your friends and family, if they have the expertise and capital to support you.
Angels typically take on a more personal role in your company. They often have industry connections and can help you grow your network. They could also use their insights on industry trends to help guide you. “My angels have been a fairly consistent source of information during the growth of my company,” says Aaron Vidas, founder of marketing software StrategyBox.
Venture capital firms, such as Andreessen Horowitz or the Softbank Vision Fund, are run by investing partners or companies. Typically, venture capitalists (VCs) identify high-growth startups, raise funds from clients, and invest the capital in exchange for equity.
VCs spend a large chunk of their time reading about financial news and trends, and meeting with emerging entrepreneurs seeking investment. They tend to target startups with unique product ideas, a large potential market, and an established founding team.
According to the Harvard Business Review, VCs select one investment opportunity for every 100 they review. They take big swings and, when successful, earn huge returns on investment. But getting VC funding isn’t a cure-all: 65% of VC-backed startups end up failing.
Like VCs, private-equity (PE) firms consist of investing partners who raise client capital to make investments in private companies. However, whereas VCs typically take minority stakes in a startup, most PE firms acquire a majority stake in their portfolio companies.
PEs differ from VCs in that they invest in later-stage companies, typically those dealing with stagnation or distress. The PE firm works to turn around the firm and improve its profitability, and eventually sell the business for a profit.
So, while VCs place bets on budding startups, PE firms identify struggling businesses that need help rebounding. But PE firms look at some similar characteristics, such as market growth and product lineup.
Pros of Private Investors
No interest rates: Unlike loans, money from private investors carries no interest rates and doesn’t have to be repaid.
Immediate money: Applying for and getting approved for loans and grants can take weeks or even months. A cash infusion from private investors enables a startup to begin growing right away.
No credit requirement: If you plan on getting a loan from a bank, they will look at your personal or business credit. But some private investors, especially angels, friends, and family, care only about making a bet on a potentially profitable startup, regardless of your financial history.
Additional expertise: Private investors want your startup to succeed, which means many will take on an advisory role. For example, an angel investor with industry experience could help guide you through critical business decisions.
Numerous funding sources: There are many routes to getting funding, since there are a plethora of VCs, angels, or other investors.
Cons of Private Investors
Reduced earnings: Private investors can be entitled to a part of your profit since they are shareholders. This in turn reduces how much you may be able to take home as a founder.
Misaligned goals: When a private investor finances your startup, they often take on advisory roles, but they may have different ideas for your business than you do.
If you have multiple investors, their conflicting visions for your company could result in strategic disagreement.
Strained relationships: Friends and family investors place their trust in the entrepreneur, which could strain your personal relationships if your startup falters.
Slowed decision-making: Independent founders have 100% say on the direction of their startup, but private investors can bog down the decision-making process. You will have to consult with them before making many high-level decisions, such as expanding into other markets or new products.
Economic volatility: The amount of private money available depends on the economy. For instance, a bear market may limit your options, as investors are likely to tighten their purse strings and be pickier about their investments.
How To Find Private Investors
High school friends, old colleagues, former professors — anyone can fund your startup as a private investor. Ideally, you have a circle of people you can tap from your personal and professional networks.
To find investors, create a list of people you have in your life, and identify how they can fit into your startup goals. Have they worked in your industry? Have they invested before? Do they have money? Jot down these attributes for each person to get a better idea on their prospect as a private investor.
Once you have a list of potential investors, start a wide outreach. Send emails, message connections on LinkedIn, and set up calls to pitch your startup.
And don’t be afraid to be bold: “Who do people want to invest in? Someone who is gonna do whatever it takes, or someone too shy to ask and go for it?” asks Prince.
Private investment centers on networking. While you can leverage your current network, try to grow your connections so you can expand your potential investors pool. You can participate in pitch competitions, such as the SXSW Pitch, which are good opportunities to meet entrepreneurs, mentors, and investors.
If you feel ready to take on a VC, start by curating a list of firms that cater to your startup’s industry or niche. For example, some VCs, such as Backstage Capital, invest in startups founded by women, people of color, and members of the LGBTQIA+ community.
Identify a point of contact, and get in touch with them. If you have mutual connections on LinkedIn, have them set up a chat with the VC. Since most VCs get their deals via referrals, you will likely have to send many messages before receiving a response.
Alternatively, you can grow your network by joining LinkedIn business communities, such as The Startup Club. By engaging with others and promoting your idea, you could attract professionals interested in investing.
Private Investors for Small Businesses
Many banks and investment firms require a history of solid financials and growth before giving out investments. As a result, small businesses stand to benefit the most from private investors.
Friends and family can always help out your company, but there are other organizations that cater exclusively to small businesses. Small Business Administration (SBA) offers a Small Business Investment Capital program, which helps match businesses to investors. There are also small search fund investors that will work with small businesses
To grow your network, you can join communities of small-business owners, such as the Small Business Connections group. You can also search for local communities of business owners who operate in your city, county, or state.
The Small Business Investor Alliance (SBIA) has events you can attend to network and source funding. The Small Business Expo, which hosts live events all year long, offers an opportunity to network with small-business owners across the United States.