What is the standard percentage to get in return for investing in a company?
I have been approached by a group of doctors that are opening a hospice. They want me to be a partner at 4.9% and give $100,000.00. Does this sound right? I am not sure if this is a fair deal. They handed me a business plan that looks like the profit will be around a million or 2 per year. Does this sound pretty standard?
There is no such thing as standard ROI in investment as it all depends on Risk, Alternative Opportunities, and current ROI in prevailing interest rates and other financial instruments.
Business plans are great but new start up businesses rarely meet their forecasts. Also there is huge difference between $1m and $2m profit. Not withstanding that there is 100% difference between the 2 but the question is what assumptions have been made in these forecasts. These include costs, demand, pricing, etc. The reliability of these numbers determines how reliable the profit forecasts are.
Secondly, whilst medics are great at their job, their expertise in their respective medical fields does not necessarily make them good business managers, people managers, or decision makers. The question you need to ask is where is their business expertise? What responsibilities have they had in managing large budgets? What experience do they have in managing a business? What track record do they have in marketing their services? Just because they are qualified Doctors, it does not make them business people.
Thirdly $100,000 is giving you 4.9% of company so the full company is being valued at roughly $2,000,000. How did they come up with this valuation? Do they have assets such as buildings, etc. that are tangible assets? Is this based on forecasted revenues and profits? How sound are these assumptions? If the company is genuinely forecasted to generate $1,000,000 of profits per year, then this is cheap, however, most start ups do not meet their forecasts and in fact are a money pit for the first 2 to 5 years.
If the business plan is really watertight then the owners will have no problem raising money from banks and traditional funding sources. The reason start ups go to individual financiers is because their business plans are too risky for banks. In these cases the financiers would demand much higher return than banks. Bearing this in mind, check what banks charge for borrowing of similar amount for unsecured loans (not property mortgages as they are secured loans against assets). I suspect this comparison may prove that you are not getting enough shares for the risk you are taking. Remember as a finance source of a business, you are an unsecured creditor, so if the business goes bust, you are the last in the queue to get your money which means virtually zero chance of getting even a penny in a $.
My advice is to ask a professional to review their business plan, assess their assumptions (not just the formulas in the Excel sheet), and examine the business case before you part with your money.
I hope this helps.
Ali's response is quite good. Your primary concern is regarding the risk involved in the investment however the issues raised by Ali do provide some concern and requires investigation in my opinion. The question of the valuation of the enterprise and how it was determined is a very good place to start. It is likely that the valuation has been generated based upon the projected sales which may or may not be a good forecast of what will actually happen (see Ali's comments). What actual business experience does the enterprise have (startup versus established business and managerial experience in this field)?
Another key question is what does your 4.9% buy you? What involvement do you have in management decisions? How many other investors are there? How do you handle disputes with management? Is this a partnership or speculative investment (or other form of business arrangement)? How do you get your investment out if you disagreement with management and want to discontinue your relationship?
I agree with Ali's recommendations. Get yourself a certified CBV (Certified Business Valuation) expert and conduct a due diligence assessment of the value of the enterprise. Talk to other competitors or industry professionals about the startup issues or ongoing industry issues and match those issues back to the business plan. Get as much information as possible prior to investing. Ali is correct: its your money to lose, it's your risk to manage.