How Do Investors Get Paid Back?
There are multiple ways to pay back a business investor—whether in regular installments, with equity, or through a straight repayment.
In some cases, an investor might not want their cash back!
For example, they might prefer to increase their stake in the company in return for an increased capital injection. Others will invest on a short-term basis and expect a repayment by an agreed date or crystallization event.
As there are several potential investment structures, it's wise to ask questions, such as
“what is an advisory share?”, in order to explore all your options.
But if you're unsure how investors get paid back, your first decision is to figure out the amount that you'd like them to invest and what you're willing to offer in return.
Let's dig a little deeper and explain some of the repayment routes and what types of returns might be a fair percentage for an investor.
What Are The Three Types Of Investment?
Before we discuss repayments, it's crucial to clarify that investment can take many forms. These are the three most common structures:
Equity Investment
Your investor contributes money now, gets a stake in the business, and receives a proportion of the profits as the company grows.
Investment Loans
Debt-based fundraising is as simple as a bank loan, except it's the investor you pay back in installments, which is often the initial principal amount plus interest.
Convertible Debt
Convertible debt is a hybrid of the other two investment types.
Your investor contributes capital, which either gets repaid (like an investment loan) or swapped for equity shares (like an equity investment) upon reaching a specific event. That might be at a fixed date or after the business reaches a particular valuation.
As we can see, your investor repayment strategy will depend heavily on the style of financing they've offered.
Why Pay Back A Start-Up Investor?
Investors aren't typically philanthropic, so they'll be expecting a return on the investment they've advanced to your business.
Generally, we'd view a return of between 20-25% as reasonable for an angel investor and an ownership stake of around 40% for a higher-risk venture capitalist. However, suppose you're repaying an investor simply because you have the liquidity to buy back share ownership.
In that case, it's essential to clarify the original investment terms and think carefully about the potential fallout. If you haven't discussed those expectations, it's never wise to go into an investor-investee relationship with the sole intention of buying them out.
Most angel investors will hold onto their shares until the business is sold—if that happens. So aside from investment loans, it's usually a long-term partnership.
How To Repay A Business Investment
There are a few primary ways you'd repay an investor:
Ownership buy-outs: You purchase the shares back from your investor depending on the equity they own and the business valuation.
A repayment schedule: This is perfectly suited to business loans or a temporary investment agreement with an assumption of repayment.
Preferred rate repayments: The investor receives a priority repayment according to your pre-agreed conditions.
Share transfers: You pay back a loan by swapping the debt for equity shares, repaying the investor with a proportion of the business equivalent to their investment.
Each repayment scenario applies to different situations and links back to the investment types we talked about earlier.
There isn't one correct route. It's all about establishing why you are buying out or paying back your investor and the nature of their involvement in your business.
A note of caution to keep in mind. Equity investments are the golden geese of start-up businesses. There is no repayment schedule, and the input from established professionals can be worth a whole lot more than the cash they've contributed.
Thus, paying them back isn't always the right option!
Investors can get paid through dividends and capital growth, so a share buy-out or other repayment isn't always mutually beneficial if their ongoing expertise will be valuable to your business.