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How Do Investors Get Paid Back? A Simple Guide

Australian dollars cash shows how investors get paid back

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How do investors get paid back?

If you’re in the process of launching a startup and raising capital, asking “How do investors get paid back?” could be one of the top questions on your agenda.

 

Here’s all you need to know about paying back investors and ending this chapter of your startup journey to reach a positive outcome for all parties.


The Importance of Exit Strategies

Before you can answer the question “How do investors get paid back?”, it’s important to understand your exit strategy. Exit strategies are needed from day one, as they lay out the future intent of the startup as it relates to how investors get paid back.


Very few investors back businesses purely out of the goodness of their hearts, even if funding a venture that they care about. Angel investors will often want equity ownership equating to up to 25% while venture capitalists may want 40% for their investment.


Additionally, high-net worth individuals such as retirees who are looking to help startups by imparting their business experience and commercial knowledge, may only look for a small 1-5% share in exchange for their time (known as 'sweat equity') rather than a monetary investment.


An exit strategy defines the planned route of the direction of the startup in the future, and how investors will be repaid, as well as making a return on their investment. Having a clear exit strategy right from the beginning delivers several benefits:


  • Investors can see a clear path of how they’ll make a ROI.

  • Investors can limit their exposure if the startup fails.

  • Owners gain direction from the goal-setting elements.

  • It provides clarity and fairness for all parties.

  • It provides transparency and a clear direction for the startup.


Most true startups are looking to eventually go public and entice more shareholders via the stock market with a sale to a bigger corporation being the exit goal. However, with an exit strategy, founders who are not looking to become the next 'unicorn', like Canva, will gain an understanding of how they can regain 100% control. If you are building a business that will remain as a private small business, like over 97% of businesses, you might not need a huge amount of capital. In this case, you might be looking for more of a 'business loan', than an investment.


Understanding Different Types of Investor Returns

When thinking about “How do investors get paid back?”, you should be familiar with various types of investment returns.


Still, founders could look at several types of investor returns. They are:

 

  • Capital gains - selling their investment for more than they originally paid. Short-term is anything up to 12 months and long-term is anything over this.

  • Dividends and distributions - when the company pays out its shareholders. This is usually done quarterly or annually.

  • Interest - this is when an investor gets a return based on bonds and fixed fees. This is essentially a loan, and not relevant for private investors who want equity.


 

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Exploring Repayment Options

As well as knowing the type of investor payouts, it’s important to know the repayment options. Aside from supporting exit strategies, it will help you when finding investors or building a pitch.


The main options to consider are:


  • Ownership buy-outs - when the business buys shares back from the investor once it is in a position to do so.

  • Repayment schedules - usually used for loans, this model uses periodic repayments until the investors have been repaid.

  • Preferred rate - this repayment route gives the investor priority repayments as per the terms agreed at the time of striking the deal.

  • Share transfers - you pay off a debt with equity shares, which could also increase their initial stake in the business.

 

Ownership buy-outs often work out as the best choice for all parties. Either way, repayments should be made when the company is positioned to do so. This could come from selling equity, cash flow from ongoing operations, or issuing debt.


Tips For Ensuring Timely Paybacks

The goal of most entrepreneurs is to repay the capital used to launch the company without compromising its growth or value to investors. Here are some tips for timely paybacks:


  • Bootstrap and reduce costs to become profitable far sooner.

  • Work harder and smarter to generate enough revenue.

  • Consider lines of credit and other tools that may support you.

  • Communicate with investors as most won't care about fast repayments, they are usually in it for the long-term gain when the business sells or goes public.

  • Have a schedule in place as it will force you to take action.

  • Automate payments where appropriate.


Final Thoughts

Above all else, you should stay transparent at all times. In turn, you should unlock better results for the business as well as its investors. Perfect.

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