Planning an exit strategy
When you invest in an untested startup, you could be tying up your money for a while. A new business could burn through your entire investment before opening its doors, then take years before it earns a solid revenue stream, Landers says.
But even if the enterprise is successful and you start getting dividends, it could be difficult to withdraw your initial investment. Pratt says a person should be prepared to wait a minimum of five years before he or she has any access to that capital or some kind of cash flow.
"There is almost never any kind of statement that says anything about expectations from an investment or any kind of guarantees," says Pratt.
Landers says it is important to discuss some kind of "exit strategy," which would include a way to liquidate the investment. Whether it's set by time or return, he says there should be a plan laid out for how to sell off your stake in the business. Unlike a public company that trades on the open market, you can't sell your stock in a private corporation with the click of a mouse.
"You have to ask yourself how you're going to get the money back out. (Buying in) is one thing, but getting your equity out is another," Landers says. "You want to understand the exit strategy. There really should be a plan in place by the owner to address it."