Investing in a company, return calculations

[ywouldi]

I have a friend who has started a business and is doing reasonably well, looking at about 90k turnover for first year. He needs investment but can't get it from banks due to a poor credit rating. He has asked me to invest for 1% per 1k I can offer and will limit that to say 10 or 15 years. Sounds good but would that ordinarily be 1% of turnover or profit?

I suspect profit will be minimal for several years and if that is the case it's not worth doing. Ifbased on turnover however it's a good deal.

[Twin2]

are you sure he doesn;t mean 1% share of the business for £1k, so you could invest £50k and be 50-50 partners?

[Doofus]

Twin2 said:

are you sure he doesn;t mean 1% share of the business for £1k, so you could invest £50k and be 50-50 partners?

£1k for 1% values the business at £100,000 now. That is, the value of its net assets. He's potentially offering to screw you over, and you don't apear to know enough to stop him doing so.

[INWB]

Seems like someone has watched dragons den once too often.

If he is offering shares in return for investment then you need to establish what a share is worth based on the business valuation. £90K t/o with 20% gross profit at a 3 times escalator would put the value of the business at £54K. So putting in 27K would give a 50% share.

My recommendation would be that you involve a business broker and expert because I have seen many friendships ruined by this sort of thing. Do it right or not at all.

[DSLiverpool]

Good way to lose a friend OP - if you value your mate then dont do it.

[Simpo Two]

Or, if you want to help him but with possibly lower risk/possibly lower return, set up a loan? That might show how keen he is for you see to see any of your money again...

[AyBee]

Simpo Two said:

Or, if you want to help him but with possibly lower risk/possibly lower return, set up a loan? That might show how keen he is for you see to see any of your money again...

I think I'd rather have equity if it's being offered rather than a loan...(unless you set the loan up properly so that you take control of the business if he defaults on your loan). I'd stay away OP if I were you.

[ATG]

ywouldi said:

I have a friend who has started a business and is doing reasonably well, looking at about 90k turnover for first year. He needs investment but can't get it from banks due to a poor credit rating. He has asked me to invest for 1% per 1k I can offer and will limit that to say 10 or 15 years. Sounds good but would that ordinarily be 1% of turnover or profit?

I suspect profit will be minimal for several years and if that is the case it's not worth doing. Ifbased on turnover however it's a good deal.

With respect, how can you conclude "it sounds good" when you don't have any idea at all what's on offer?

It might be easier to think about this by considering two simple ways in which you could invest.

You could loan him money for a fixed period of time at a fixed interest rate. It should be relatively easy to choose an interest rate that you think would be fair by looking at the interest rates you could receive from other investments and how much you'd have to pay to borrow the same amount; anything that gives you a feel for the sort of rates that get charged for loans of whatever term you pick.

You could buy a percentage of the business. Let's say you bought 20%. You'd own 20% of any equipment owned by the business. You'd own 20% of any profit the business makes. You'd get a 20% say in any decisions that need to be made about the business. So how do you put a price on that 20%? By valuing the business's assets and liabilities and by trying to guess how it is going to develop in the coming years. How much might it grow? What margins can it achieve? How likely is it to go bust? And be very clear if ownership is going to mean you become liable for any of its debts or other contractual obligations.

Once you've considered those two extreme cases you could then think about some hybrid of the two. Maybe you loan him money but make the interest payments a function of how much profit he makes. He gets a cheaper loan if the business is slow to take off; you get a share of the profit if/when it becomes successful. And of course there are as many possible hybrid arrangements as you could care to dream up.

[StevieBee]

I'd add to the list of very good advice already posted to be wary.

I mean no disrespect but you seem to not appreciate the difference between turnover and profit. Couple this with a friend with bad credit...the signs are not good. On the latter, there are a great many people with bad credit these days and whilst they would not necessarily get a loan for a car, banks are more inclined to lend to businesses owned by these people if the business plan is sound unless that person has outstanding debt personally as the risk to the bank is that the money they lend could be used to pay off those personal liabilities.

If you do decide that everything stacks up, then two questions you need to ask yourself before you hand over any money:

1. "If I never see that money again, would it be a problem to me?"
2. "If I never see the money again, would that affect the relationship with my friend?'

[trickywoo]

Apart from the advice so far there isn't anything anyone can say without knowing a minimum of what the profit is and what he plans to use the money for.

Even then without masses of detail its likely only a decision you can make.

[All that jazz]

ywouldi said:

I have a friend who has started a business and is doing reasonably well, looking at about 90k turnover for first year. He needs investment but can't get it from banks due to a poor credit rating. He has asked me to invest for 1% per 1k I can offer and will limit that to say 10 or 15 years. Sounds good but would that ordinarily be 1% of turnover or profit?

I suspect profit will be minimal for several years and if that is the case it's not worth doing. Ifbased on turnover however it's a good deal.

Open your eyes and stop being a mug. All the alarm bells and warnings signs are showing right there.