Understand the structure
Shannon Pratt of Shannon Pratt Valuations in Beaverton, Ore., says potential investors should carefully understand the business structure. It can determine how the IRS and legal system view liabilities and profits. Chances are strong that the business could fail -- according to the Small Business Administration, approximately 50 percent of small businesses close within the first five years.
Depending on the structure of the business, you could be personally responsible for unpaid bills or liabilities in the event the business fails. Pratt stresses that investors should think hard about limiting their liability and recommends sticking with a limited liability corporation, or LLC. One of the most important attributes of an LLC is that owners are not usually liable for company debts.
"Without forming an LLC, if they go out of business and have liabilities, all of those stakeholders likely have the right to come after you (personally)," Landers says.
Coffman says people often make the mistake of investing in a friend's or family member's business with little more than a handshake. No matter how close a relationship you have, Coffman says drafting official documents and putting things in writing is essential.
"It's often very informal, and there usually isn't a lot of evaluation. If you want to do it properly, you need to have legal documents drawn up," he says.