When someone is looking to invest in your business and you're talking about how much money you've passed a couple of investor smell tests. They like aspects of your business enough to overcome the fear of risk. That is a great thing. But now is the hard part in the negotiation. If your exchanging money for equity (stock/ownership) now you have to value the business. If you look at it as straight common shares then it's a matter of what percentage of the business will be handed over for what amount of money. If someone gets 50% of the business for $100,000 then you're valuing the business at $200,000.
This seems pretty simple but then it gets all emotional. The founder/owner allows thinks the business is worth more than the investor will. This most commonly happens because the owner is biased towards success and the investor is biased towards failure (risk). I've seen several investment deals get so close to completion and then fail over five or ten percent difference in perceived value of a company.
Why go through all that? Make the investment a loan. Loans are simply contracts between two parties. Loans are highly flexible and have many advantages. As a matter of fact I recommend that if you own the business and you are going to put money into the business, structure it as a personal loan from you to your company. Typically repayment of the principle is tax free (interest is income). Often if you sell the business you can settle the loans as part of the deal.
Here Are the Pros:
- Loans can be negotiated one off and have no impact on additional or alternative investment terms. Often equity investors want to be guaranteed they have the same deal as everyone else so if you cut one person a great deal usually everyone else has to get it too. This is not the case with loans. They are one off contracts.
- You set a schedule of payments and how much those payments are. This makes for predictable financial structure and easy cash flow planning.
- Loans holders don't care about the details of your buseinss (get in your way). All they care about is getting interest and principle payments on time.
- You can have unsecured loans (just a promise of payment) or secured loans (you put up inventory, intellectual property, real estate or personal assets as collateral against default).
- You can structure loans as "senior" debt which means loan holders get paid in bankruptcy before most others.
- Loan money put into the company can be scheduled and tied to mild stones in your business (not just one lump sum).
- Loans can be structured to be paid off early.
- Loans can be convertible instruments which means the principle can be converted into stock (i.e. ownership).
- Loans can often be more easily sold to someone else (liquidated) than stock in a non-public company.
- Loans can have stock/equity bonuses (kickers).
If you haven't noticed loans as investment vehicles have a lot of positives, for both the investors and the owners of businesses and don't forget don't just put your own personal money into the business, write yourself a loan. NOTE: Each state will have certain restrictions on loans so make sure you get some help from an attorney.