Types of Investors: Which Is Best for Your Business
Jul 19, 2021
Every investor has a unique portfolio, informed by a certain set of goals and a strategy for achieving them. Business owners who know what investors are looking for are better equipped to position their business in a way that attracts the type of investor that best suits their needs.
What Is a Business Investor?
Any individual or organization who commits capital with the expectation to eventually receive financial returns is an investor.
This broad definition includes everyone from startup accelerators to Wall Street institutions and even family members who loan money to one another. All these examples buy into long-term strategic positions and expect their assets to appreciate in value over time.
Most investors generate returns through equity investment, debt investment, or both.
- Equity investment means owning part of a company’s stock. If the stock pays dividends or raises in value, the investor earns profits. The investor realizes those profits upon selling the stock.
- Debt investment is structured as a loan. In this case, the business owes a certain amount of money to the investor and pays it back with interest over time.
Some investors look for low-risk opportunities that lead to conservative gains over time. Others are willing to take on substantial risks to make a larger profit. Private equity investors who buy ownership stakes in small businesses take on risks that many other investors may not be willing to consider.
Three Types of Investors
This is a catch-all term for people who have not yet begun investing. It excludes all professional investors but includes friends, family, and close personal contacts. These are people who may have capital that they are willing to invest in your business but are otherwise new to investing.
Businesses in their earliest stages may only have access to pre-investment funding from close personal contacts. At this point in the business lifecycle, you probably don’t have hard evidence or any solid indicator that your business will be successful in the long run. Pre-investors are investing in you personally because they know you, trust you, and believe in you.
These types of investors generally don’t provide a lot of money up-front. Depending on the amount of capital your pre-investor has available, it could be as little as $1,000.
2. Passive Investors
Passive investors limit the amount of hands-on management they personally provide to assets they own, adopting a buy-and-hold mentality that they expect to pay off in the long run. Instead of playing an active role in the management of a company, a passive investor will defer to the management team’s operational and financial decisions.
This is commonly the case for investors who do not own a controlling stake in the company they invest in. Passive investors usually invest in companies with management teams they believe in and rely on those teams for expertise and guidance.
Angel investors are one kind of passive investor. These are high net-worth individuals looking for brand-new businesses and startups that they believe will perform well in the long run. Often, these businesses are so small and new that they have not yet started producing any profits. As a result, angel investors can make hundreds of times their initial investment when they choose a successful asset.
However, angel investing comes with a great deal of risk. Angel investors often don’t have any real control over how companies are run, and there are no guarantees that a startup will ever become an industry leader. Beyond informal influence over company leadership, angel investors have little say in whether a startup succeeds or fails.
3. Active Investors
Active investors take a hands-on approach to managing their portfolios. These are investors who want to exert influence on the way their assets are run. In a private equity context, active investors may bring in new people to help bolster management teams and assertively make structural changes to the way a company works.
Active investors look for opportunities to make operational, financial, and administrative changes based on their own knowledge and experience. As a result, active investing usually involves greater risk, but it can also deliver greater returns when successful.
In order to exert influence over company operations, active investors typically aim for a controlling stake. This also increases exposure to risk, so these investors spend a great deal of time and energy on financial analysis and valuation before buying in.
Venture Capital Firms
Venture Capital firms are a type of active investor. These firms invest in businesses a little later in the development life cycle than angel investors. In the typical venture capital case, the business already has a proven business model in place and may already be generating revenue. However, it needs more resources to scale its operations sufficiently for generating significant profits.
Because venture capital firms come into the picture later than angel investors do, they typically earn lower multiples on their successful investments. While an angel investor might make 100 times their initial investment in a successful company, a venture capital firm may earn ten times their initial investment.
However, venture capital firms expose themselves to less risk than angel investors. As active investors, they usually ask for a seat on the board, which enables them to help guide company decisions, even if they don’t necessarily have a majority stake.
Private Equity Firms
Private equity firms look for mature, well-established businesses to invest in. In many cases, they seek a majority stake in a business and use proven leadership skills to improve business performance over time. This strategy is usually less risky than venture capital or angel investment, especially when the private equity firm takes a majority stake and brings its own management experience to the table.
Which Investment Strategy Is Right for Your Business
Professional investors usually look for businesses that have specific characteristics that fit their portfolio. They may be looking for businesses that operate in an industry or geographical area they know well. They may focus on businesses of a certain age, with a certain market capitalization, or with specific operational or financial needs.
The better you know your business, the easier it will be to find an investor willing to hear your pitch and provide the resources your company needs. Researching investor portfolios is also a great way to filter potential investors. Compare your company to the other companies in the investor’s portfolio and ask yourself how similar your company is to the others on the list. If you find someone who consistently invests in companies like yours, the chance of attracting their investment is much higher.