investing

5 things to know before investing in business startups

You may not see returns for years
You may not see returns for years © yanugkelid/Shutterstock.com

Assuming you invest in a startup that stays afloat and makes a profit, it could be years before any of those profits come your way.

"A startup is going to need all the cash they can get. Earnings are usually plowed back into the business (for the first few years). Any return might not be for three to five years, and there is no guarantee," Coffman says.

If an investor has a particular targeted time frame for a return of capital and a yield they'd like to earn, Coffman says they should consider investing via a loan instead. Putting a large sum in a business based on trust and the hope for dividends later has no guarantee. But making an official loan to the entrepreneur or startup at a market-based interest rate with a determined term can give the investor a steady income stream and a more guaranteed return of principal.

Consider that offering a 10-year loan of $10,000 at 7 percent would net a payment of $116 per month and a total of almost $4,000 in interest over the life of the loan. Coffman says such loans might be a more common way to invest in a friend's business but still recommends making it official with proper documentation and legal paperwork.

"Sometimes the loans are never repaid in these arrangements. If you really (want your money), you need to make it official," he says.

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