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Cashing in with an investor prospectus.

This story is an old one. All too often, the first-year entrepreneur who needs a relatively modest amount of capital either finds local lenders reluctant to become involved with a "high-risk" borrower or finds traditional capital sources uninterested in such an "insignificant" investment.

The advice often given to the entrepreneur is "try friends and family." How does one succeed in raising money this way? A simple two- or three-page investor prospectus supported by a carefully designed business plan can be an extremely effective tool.

The most important thing for any entrepreneur using this method is to approach the objective intelligently. The prospectus should clearly state exactly what is being offered in return for the investor's money. Some of the details on emight put in a prospectus include:

* How the return on the investment will be determined and distributed.

* Guarantees (if any) that are being offered to reduce the degree of risk to the investor.

* Exit requirements for the investor wishing to pull out of the agreement earlier than anticipated.

* Length of time the prospectus terms will remain in effect.

* Avenues of recourse available to the investor in the event that the business should fail or be sold.

The major advantage to the entrepreneur is the fact that the terms of the prospectus can be written in whatever manner best suits the needs of the business. This is rarely the case with conventional financing.

For example, John Q. determines that he needs $15,000 ini additinal capital to launch his business. After careful development of his business plan and reasonable projections for his first year in business, John conservatively estimates that he can achieve $100,000 in first-year sales with roughly $12,000 in net profit after all expenses. In return for the $15,000 investment, John is willing to offer 15 percent of his net profit--that's 1 percent for each $1,000 invested.

(Note that John is not selling any part of hiss business, but rather offering a share of this net profits. The wording of the agreement is important. What this prospectus outlines is basically a personal loan rather than a stock offering, so securities regulations should not apply).

He reasons that the arrangement will allow profit opportunities for both the major and minor investor. Due to the uncertainty of actual net profit, John decides that he will offer an annual guarantee of at least 10 percent earnings on the investors' money to make his offering more attractive. Some additional terms that John has outlined in his prospectus include:

* The investors' share of profits will be paid quarterly.

* The investors may review John's books at any time with two weeks' written notice.

* The life of the prospectus will be three years, with John repaying the original principal at that time.

* John reserves first purchase rights in case any investor wishes to sell before three years pass.

* In the event of business failure, John has a three-year grace period in which to repay the original principal, less any payments made. (This clause, in effect, makes John liable only for the original money invested if the venture fails.)

If the profits are as John has projected, the investors will realize a 12 percent return in the first year, a rate much more attractive than that of many other investment vehicles. If not, making good an the 10 percent guarantee will cost John no more than $1,500 a year.

Quite often an investor will readily agree to terms such as these, whereas a bank certainly would not. The incentive that attracts the investor is the possibility of realizing substantial returns on his or her investment.
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Title Annotation:Small Business Tips
Author:Williams, Neil G.
Publication:Indiana Business Magazine
Date:Oct 1, 1993
Words:604
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