Would you ever invest in small local startup?

[FIRE Realtor]

I had never considered this, but we were presented with an interesting opportunity the other day.  There is a local business that's been around for 4 years, making a product that I believe has a lot of potential due to many things I've read over the past year - Non Alcoholic Craft Beer - I've been "sober curious" for awhile and studies show younger people are drinking less, more bars are offering high end NA options, etc.
This company has slick marketing and is already in local stores, Whole Foods, and Total Wine.  It's just a couple guys who are not friends of ours but we know through business contacts, so there is some level of trust. 
They are currently seeking investors to give $50K each with a goal of $1M, a loan for two years with 7% interest and a bunch of other options I do not understand. 
We have that much in cash and are wary of stock market right now (no other debt besides mortgage).  We'd be more comfortable doing $25K which may be an option. 

Under what circumstances, if any, would this be a smart move?  What additional questions would you ask?  Would we make a whole bunch if they were bought by a large national beer brand, which they are currently considering? 

[sixwings]

I would consider asking about their revenues, their margins, if they pay themselves and how much. Also you will want to know what do they plan on doing with the money - how will it be used to expand their growth. You dont want them to say they need to pay themselves more. 100% of the investment should go into growth. I'd also want to know more about their customers. Like with Whole Foods, is it a trial contract that they have or is it recurring? I dont know much about the beverage space, but is their drink formula proprietary?

You also want to be pretty clear on how much equity you will get and how much they will retain. They are looking for 1M, how much equity are they giving up for that? I often find founders want to give up like 10% of their company and want a lot of money for it, and it's not really worthwhile. What's the board/governance like? Would you be on the board? Who is on the board? Do they have experience building a beverage company? 

Also, if they are looking to do pretty complicated raises that to me would be a signal of issues. You mentioned that there was a bunch of other ways they were trying to raise capital that you dont understand. I would try to understand that. As a potential part owner you would need to understand where their funding is coming from and how it may impact your equity in the company.

Finally, everyone dreams of the big buyout by larger companies. That's very rare. It's possible you could make a lot but it depends on your equity, how watered down you get in the process of getting there, etc. I wouldnt bank on a big exit like that.

As funny as it sounds, Shark Tank or Dragons Den is not an awful show to watch to think about the kinds of Q's that you may want to ask. There's a lot of drama that is made for TV and the process of giving an offer and acceptance on the spot is not how that actually works, but they do ask good Q's to try to understand the company, the customers, the growth potential, etc.

[erutio]

A couple quick thoughts:
- Why can't they get a small business loan?
- A private, unsecured loan should be returning much more than 7%.
- You should have access to all their financials for the past few years before making decisions.

[celerystalks]

I had never considered this, but we were presented with an interesting opportunity the other day.  There is a local business that's been around for 4 years, making a product that I believe has a lot of potential due to many things I've read over the past year - Non Alcoholic Craft Beer - I've been "sober curious" for awhile and studies show younger people are drinking less, more bars are offering high end NA options, etc.
This company has slick marketing and is already in local stores, Whole Foods, and Total Wine.  It's just a couple guys who are not friends of ours but we know through business contacts, so there is some level of trust. 
They are currently seeking investors to give $50K each with a goal of $1M, a loan for two years with 7% interest and a bunch of other options I do not understand.
We have that much in cash and are wary of stock market right now (no other debt besides mortgage).  We'd be more comfortable doing $25K which may be an option. 

Under what circumstances, if any, would this be a smart move?  What additional questions would you ask?  Would we make a whole bunch if they were bought by a large national beer brand, which they are currently considering?

Red flag.

Also, to me the business idea seems shaky at best. The competition for the beverage is not other beers, but all other beverages.  If I want a a beer, I have a real beer. If I want something non-alcoholic, I prefer a soda, gingerale, root beer, gatorade, seltzer, iced tea, etc. I don’t think I’d ever bother trying a non-alcoholic beer. 

[terran]

I would not invest in a business like this, but if this is a small enough amount of your overall stash (say 5%?) and you want to "invest" it as fun money (similar to how some people do individual stock picking with a small amount of money) knowing that you could lose it that wouldn't be unreasonable. Basically consider it an experience that might payoff or might not. Being involved in the business without actually having to run it might be fun.

Here are a couple of posts from a FIRE blogger and sometimes poster @PhysicianOnFIRE that might be interesting for your take a look at: https://www.physicianonfire.com/badinvestment/ and https://www.physicianonfire.com/craft-brewery-investment/

[reeshau]

As funny as it sounds, Shark Tank or Dragons Den is not an awful show to watch to think about the kinds of Q's that you may want to ask. There's a lot of drama that is made for TV and the process of giving an offer and acceptance on the spot is not how that actually works, but they do ask good Q's to try to understand the company, the customers, the growth potential, etc.

This was exactly my first thought.  Some companies are on there just for publicity / drama, but if you look at the serious discussions, they do have good questions.

I did loan money once to a bakery that was moving out of a home kitchen / farmer's market stand into a retail space.  He had a small business loan coming, but the bank was dragging its heels and his first month's rent was due.  I had been his customer and gotten to know him for over a year.  It was a small amount of money, and he named 10% as the interest.  I didn't haggle--Would have done it as a favor, but he has his dignity, and the business was growing up.

Back to your situation:  agree with the questions given.  Trust is one thing: you don't want to be suckered into a scam.  But they will most likely be out of business in 5 years, despite their best efforts.  It's a dangerous world out there!

Questions:
What has your revenue and profitability been each year since startup?  What are your projections for this year and beyond?

Are you working this full time?  What are you paying yourself?  (If you are investing, they *should* be paying themselves something; otherwise, their profitability is inflated)

What is the equity for this investment? (and therefore, company valuation)  What will the investment be used for?  What further investments will be needed down the road?

What are your distribution channels?  Which are the most profitable?  Which are growing?  What ones do you want, that you don't have?

How are you marketing?

Who are your best competitors, and what are they doing that makes you think so?

The best answers would be ones they know immediately, to show they have been thinking about it.  The more specific the numbers are, the better.  Notes are fine-organization means a lot too.  But blowing off your questions, or obviously improvising an answer is a big danger sign.  I also like Mark Cuban's red flag of quoting big total market sizes rather than focusing on your specific opportunity.

[Proud Foot]

I would not be opposed to investing in a business like this, however it would be a small portion of my overall portfolio.

For you I would suggest no for investing for reasons unrelated to the business.
You mention you do not understand all the investment options. You really need to know what/how you are investing or it can go badly for you. While you may have heard about them trying to raise funds you may not be eligible to invest at this time and that all comes down to the method the business is using to raise funds.
Having slick marketing and already being in local stores does not mean it is a good business. You need to look into what the agreements are for those stores as well as the financials for the business.
What is the growth rate in sales"
What is their gross margin?
What is their net margin?
What do they plan on doing with the funds they raise?

[bbqbonelesswing]

Under what circumstances, if any, would this be a smart move?  What additional questions would you ask?  Would we make a whole bunch if they were bought by a large national beer brand, which they are currently considering?

Not to sound snide, but if you have to ask, and don't even understand the investment terms, this is not for you. Maybe take a few books out of the library and read up on investing in small businesses before you drop $50k on something.

[PDXTabs]

I like the idea of the product, but I would insist on an equity position, not a loan.

[Steeze]

I like the idea of the product, but I would insist on an equity position, not a loan.

+1

[Retire-Canada]

We have that much in cash and are wary of stock market right now (no other debt besides mortgage).   

What additional questions would you ask? 

You are wary of the stockmarket where your money is likely to compound at a decent rate over the years being invested in a wide range of companies and the chance of losing it all is very slim so instead you want to invest in a start up??? Sorry that doesn't compute at all.

[KarefulKactus15]

You are wary of the stock market but willing to invest in this single asset that seems to be an emerging market that is not yet fully proven? (for 7% ROI?)

Also there had better be some equity in addition to the 7%. That seems low for the risk.

Any idea what kind of profit margins they have? Owner salary? Previous years growth? Whats a brand new start up have to spend on marketing to bring a new idea to market like that. (I say new, but maybe its just new to me... At the same time I personally find myself seeking alternatives to craft beer due to calories and all..)

As someone else said - Why are they not getting a business loan?   I previously almost considered a similar proposition from a friend, BUT -> there was equity involved.  I asked him why not just get a small business loan and his (honest) answer was that he could get a small business loan and not give up any equity, but he wanted to have a second person to bounce opinions off more than anything else instead of just a loan.

[trollwithamustache]

start up investing is not for the faint of heart and shouldn't be done with investing money. It should be done with play money. The overall risk-reward may be decent, but its binary... you either win big or loose everything, and most of the time you loose everything. That is why rich people use VC funds.

That being said, IF you understand the COMPLETE ownership structure, it can be fun to invest and then follow the little guy. 

[PDXTabs]

start up investing is not for the faint of heart and shouldn't be done with investing money. It should be done with play money. The overall risk-reward may be decent, but its binary... you either win big or loose everything, and most of the time you loose everything. That is why rich people use VC funds.

Yup, good VC firms win ~1/3 of the time. But they do it for equity, they do not give out loans. Obviously, they make so much on the good deals that they can pay for the 2/3 that go to zero.

[seattlecyclone]

start up investing is not for the faint of heart and shouldn't be done with investing money. It should be done with play money. The overall risk-reward may be decent, but its binary... you either win big or loose everything, and most of the time you loose everything. That is why rich people use VC funds.

Yup, good VC firms win ~1/3 of the time. But they do it for equity, they do not give out loans. Obviously, they make so much on the good deals that they can pay for the 2/3 that go to zero.

VCs often insist on so-called "convertible debt," a loan that can be converted to equity in the future. This is the best of both worlds for them. They get the upside of equity investing if the company does well. If the company fails they get paid out of whatever is left before common shareholders (founders, employees) see a penny.

[trollwithamustache]

Yup, good VC firms win ~1/3 of the time. But they do it for equity, they do not give out loans. Obviously, they make so much on the good deals that they can pay for the 2/3 that go to zero.

Is the VC success rate that high? maybe this was just a solar thing, but when I worked for a couple start ups and used to follow the sugar daddy funds other investments... there was a lot more than 2/3 carnage! it seemed more like 10% make it and those that do are 20-50X profit for the fund. 

[Christof]

Non-alcoholic craft beer has been a thing here for a few years and we even see some of the larger breweries enter this market. But each market is different.

However, what strikes me most is the thread title... Investing, to me, is obtaining equity. Yes, I would invest in small local startups, but only a small percentage of my own money. But the question really is, would I give a loan to a small business. No, very unlikely! I‘ve done peer to peer lending for personal loans and for businesses and both have a high rate of failure. It only ever can work with high interest rates and a large number of loans.

For businesses the idea is rarely important. Execution is a lot more relevant.

[PDXTabs]

Yup, good VC firms win ~1/3 of the time. But they do it for equity, they do not give out loans. Obviously, they make so much on the good deals that they can pay for the 2/3 that go to zero.

Is the VC success rate that high? maybe this was just a solar thing, but when I worked for a couple start ups and used to follow the sugar daddy funds other investments... there was a lot more than 2/3 carnage! it seemed more like 10% make it and those that do are 20-50X profit for the fund.

¯\_(ツ)_/¯

I don't know, I've seen 1/3 quoted in the press before, but have no idea where to find that right now. KKR has been known to pay my mortgage.

[apricotfuzz]

Startup Founder here.  I think the sentiments here are generally right on.  From a founder perspective, there often isn't time for investors who ask tons of questions related to the business- it's a bottomless time suck (although I understand the desire from the investor perspective).

Start up investing is typically considered high risk, high reward.  By offering a loan, they've limited the 'reward' part of this equation.  The interest should be higher.

If you want more information- I would ask to sign an NDA, see the proforma and the Cap table.   This will give a pretty clear sense of where the business is, adviser etc.

Good luck!

[vand]

TBH I wouldn't.

7% is not a fabulous return on a venture that could easily default.

Banks can afford to do that because they have a large loan book, but as a private lender you have no such diversification.

Too little return for too much risk imo.

[Buffaloski Boris]

Yes but not for 7%. As other have noted, I would want equity instead. Or convertible bonds.

[Michael in ABQ]

In college I invested a few thousand dollars in two local businesses. One was a startup my roommate was running creating a sports drink. In the end I got about 5% of my investment back. The other was a local retail store selling nutritional supplements, basically competing with GNC. The owner ended up going bankrupt and I lost my whole investment. The first one was pretty speculative and frankly the valuation I was buying at was ridiculous in retrospect ($300k valuation for a consumer products company with no meaningful income or significant IP). The other might have worked out but I should have asked to see more financials.

I was young and stupid and ended up losing several thousand dollars. I learned some lessons though and got some experiences out of the former business working in it.


In general a small business will normally sell at a 2.5x - 4x multiple on seller's discretionary earnings (basically profit including owner's salary and personal benefits". So if they are quoting a $1M valuation they should either be producing a profit of $250,000 - $400,000 a year or something smaller but with significant growth, i.e. 100%/year.

[BikeFanatic]

I don’t know about the investment side, but the product is very popular right now, I have a local brewery that sells non alcoholic beer exclusively and they sell out of new offing’s in a few hours.
They ship the beer  and or have pick up, and tap room is closed for covid.

[NashMoney]

Have you ever heard of AngelList? They have something that allows investors to put small amounts, $5k etc into a company with other investors as part of one large investment. I was fortunate in investing in www.rappi.com (Postmates for LatAm) and www.stache.com (Airbnb for Storage) this way. Of course it's all high risk and I have a few that have gone belly up.