What happens when a small business cannot pay their investor back?


Date: 6 July 2022

Angel investor

When small businesses begin their start up journey, it's not unusual for them to seek investment to help the business progress. If the business successfully secures investment, there's always the risk that the company does not grow as planned, leaving the business owing the investors money.

But what happens if the company is insolvent and there is no money to return to the investors?

If the company has received investment from a professional, they may not owe them anything at all. Investors are aware of the risks when investing in a start up business. They understand that their injection of capital may not make any returns. We speak to some industry experts to find out more.

If a start up fails, what happens to investors' funding?

"Professional investors usually understand that they will not be making any returns on the funding they invested if a business fails," explains Richard Allan of funding start up, Capital Bean.

"This is the case for most start ups which fail, unless they were involved in some form of fraudulent activity or there are alternative terms associated with the investor's contracts.

"Professional investors see their investment as another aspect of their portfolio strategy, with early-stage investors usually being well aware that a portion of their investments will fail. A small portion of companies which they have invested into will make big returns, meaning that taking a risk is usually seen as a worthwhile and common aspect of the job for any investor.

"Consequently, start ups who receive investments should not panic about the potential lack of returns for their investors. They should instead focus on growing the company and reaching their personal and professional goals, as progressing the company successfully means they are more likely to make money and therefore be able to repay the investors.

"The general exception to this logic is regarding those individuals who cannot financially afford to lose their investment entirely. Consequently, the risks associated with investing in a start up should always be made clear at the outset and investment from those who are not financially stable should not be accepted."

What are the benefits of having an investor?

There are many benefits when it comes to accepting start up investment. Investors understand the risks involved for a start. This means that unlike applying for a loan, there may be less challenges when securing investment from an experienced individual or firm. Banks and alternative lenders may be more cautious and therefore limit the amount of funding they are willing to offer a start up.

Additionally, it is important to remember that investments and loans are very different. Loans are expected to be repaid, whereas investments are usually granted in the hope that returns will be generated.

Investors take an ownership stake in the company or start up in which they are investing. They can achieve sizeable returns if the company takes off. If a company fails, angel investors know that they may not get a return on their investment, meaning that financial pressure is relieved.

What are the disadvantages of having an investor?

"One of the disadvantages of taking on an investor is that a company will have to provide them with some equity in return for their funding," explains Justine Gray of consumer lender, Dollar Hand.

"This means that a start up is handing over future earnings whilst still unsure about what the business will generate in revenue. The percentage of ownership taken by the investor depends on the amount they are investing into the business.

"Another disadvantage is that founders will not always have total control over their company as investors may want to influence some key decisions. In spite of this, they may also be able to offer helpful advice and advise on areas of a business that the founders are typically unfamiliar with, meaning there may be positive aspects of this relationship."

Copyright 2022. Article made possible by Tudor Lodge Digital.

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