How To Pay Back Investors
What’s in it for me? Sounds selfish, but it’s what every investor wants to know. In addition to supporting your efforts, lenders and investors both want something from you in return: lenders want the full loan repaid with interest, and investors want a healthy return on our investment.
With equity investments, there’s no guarantee we’ll get anything back in our pockets. But that risk is why we expect an even higher return when our investments do succeed. Sure, I might not get paid back as an angel investor, but I do get ROI. And when I’m strategic about my investments, that payoff can earn me far more than the typical loan interest.
Loans and investments aren’t gifts. Here’s what you need to know about your obligation to repay capital funding and how to create the right repayment plan for you and your investors or lenders.
Understand Your Obligations
Founders lucky enough to find investors have a fiduciary duty to them, meaning you must act in your investors’ best interests. Corporate governance laws of Delaware – where nearly all startups are incorporated thanks to business-friendly laws – require founders to consider the rights and outcomes of all shareholders. Equity investors don’t get direct repayment of their funding, so fulfilling these fiduciary obligations helps secure a healthy ROI.
If your startup is performing well, you have a reasonable obligation to provide your investors with fair returns. To do that, ensure a sound financial position and focus on a steady appreciation of your business. When your business does well, we do well. The best way to demonstrate the security of our investments is by acting in the very best interests of your business. Trust me, we’ll notice.
You’re also obligated to give us full transparency. That means providing full and accurate disclosures from the start and regular updates on any changes we should know about. Monthly numbers falling drastically below projections? Tell us. Profits soaring for the quarter? We have a right to know because it all impacts our ROI.
Repayments and ROI
Anyone who provides capital for a startup expects to get something back in return. Lenders expect full repayment of their loan with interest, while investors expect a significant return on their investment.
Here’s how each type of capital typically gets “repaid” by founders.
With equity investment, your investor gives you money now in exchange for a stake in your business and later receives proportional compensation—based on how much they invested and your company valuation—when your company goes public or is sold. It’s not necessarily a repayment, but it’s usually a sizeable return.
Debt funding is a loan, often from a bank or a personal lender. When pursuing debt-based fundraising, you’ll outline your repayment terms (including the interest rate and timeframe) in your contract. There’s a good chance you’ll need to put up collateral that your lenders can take if you can’t repay the loan.
Convertible debt combines aspects of both equity investments and debt funding. Investors contribute capital now that either gets paid back (like debt) or converted into company shares (like equity investments). Lenders are often incentivized to convert debt into equity with discounts or warrants for the next funding round.
Create a Repayment Plan
A repayment plan gives investors and lenders peace of mind. Once it’s drawn up, we know we’ll get paid back on time, and you’ll know what we expect. We can also fall back on this repayment plan as a legal document if disputes arise or you fail to repay.
Most repayment plans fall into two categories: installments and bullet payments. Installments spread out payments into equal amounts over the loan term, while bullet payments are lump sums paid once, usually at the end of the term. Installments make budgeting simple, but they can rack up interest. Bullet payments can save on interest, but your cash flow will take a huge one-time hit.
Here’s what to consider to develop the right repayment plan for you.
Type of Loan
Are you borrowing from a traditional lender? Banks and credit unions usually require installments with interest. If you’re loaning money from a personal lender or a peer-to-peer platform, you might have the flexibility to choose between bullet or installment payments.
Regardless of which payment schedule you choose, interest will impact the total loan cost. If your interest rate is high, an installment schedule allows you to spread the interest cost over time, minimizing the impact on cash flow.
If your interest is low, a bullet payment schedule would allow you to pay it off quickly and save on interest.
A bullet payment schedule works well for short-term loans, since there’s not much time until it will be due anyway. If you have a long loan term, installment payments allow you to pay it off little by little, using the term of your loan to your advantage.
While the type, interest, and term of your loan should all be considered, don’t ignore your financial situation. Steady cash flow means you can likely afford a higher monthly payment, perfect for an installment plan. If you’re tight on cash and planning to see growth in the future, a bullet repayment plan would allow you to save up over time and pay once at the end.
If neither the installment nor bullet option appeals to you, consider some alternatives that your lenders or investors may allow.
- Buy back their shares
- Pay dividends to equity investors
- Sell your company or take it public
What to Include
If founders come to me with a repayment plan, I’ll need to see enough detail to instill confidence that I’ll get paid back. I’m looking for a reasonable timeline, a payment schedule of what money I can expect and when, details supporting your accountability to the plan, and contingencies such as what happens if you fail to meet these guidelines.
Communicate with Your Investors
Communicating with investors is critical to keeping us abreast of what’s happening with our investments. It creates stronger relationships, opportunities to source more funding, network connections, and investor confidence in your company. A lack of or delay in communication increases the risk that founders will be unprepared for repayment. Don’t send that message to investors.
To keep us informed of how you’re doing and how you’re preparing for repayment (in one form or another), try asking your investors how we want to be contacted. As you begin the relationship, ask your investors the following questions:
- How do you want to receive information from us?
- When do you want to hear from us and what frequency of communication do you prefer?
- How much detail do you want?
- What information is especially important to you?
Put your investors in the driver’s seat and we’ll feel more confident in you and your business.
Certain communication methods are better suited for certain kinds of communication.
The preferred form of communication and best for monthly reporting. Include helpful information that impacts your repayment, like projections, competitive analyses, and performance metrics.
Great for annual letters to provide context about the year and company progress.
Time-consuming and limiting. Only use it for serious or difficult situations, such as if you feel you won’t be able to repay a loan, or if specifically requested.
Virtual or In-Person Meetings
Use as needed for board meetings, significant updates, etc.
When in doubt, keep this in mind: You can’t overcommunicate with people who bet on you – especially as you’re paying back a significant chunk of capital, whether through returns or true repayment.
Manage and Monitor the Repayment
If you care about creating and maintaining a good reputation as an entrepreneur, you should care about satisfying your repayment obligations. Investors may also monitor things from their end, but it’s your responsibility first and foremost.
When I see a founder taking initiative to monitor their repayment, it tells me my investment is safe. If challenges arise that threaten repayment, a founder who faces those challenges head-on is more assuring than a founder who avoids or ignores them.
Managing repayment will look different for each founder. Generally speaking, add these tasks to your list to monitor the health of your repayment abilities:
- Stay up-to-date on financial or management changes and communicate those changes to investors
- Monitor compliance with relevant laws and regulations
- Review comprehensive reports, cash flow statements, and projections
- Track and record payments
- Identify and address issues impacting repayment
- Make adjustments to repayment plans as needed
While they can feel like gifts, all investments come with an expectation of return. Loans require repayment, often with interest, and equity investments await a later ROI. Either way, it’s on you as a founder to ensure your lender or investor gets what they want from the deal.
The repayment process and the form of expected repayment differs based on the type of investment you get, so use this article as a jumping-off point to design a customized plan that works for you and your investor. Then, explore other resources on this site to learn more about the founder-investor relationship and tools for success.
The bottom line: don’t go into an investment with rose-colored glasses. Know what your investor wants back from you and create a plan to make it happen.
Enjoy the ride.