Borrow money to invest in a business venture with equity?

Question

Is it generally considered a financially-sound thing to do for one to borrow money to invest in a business venture, which may not be their own? For example, Jane borrows $50K to put in to a startup and agrees to get a percentage of the equity. The goal here is to get a share of the revenue.

Obviously, she can pay this back eventually regardless since she has another income stream(s) available, but anticipates that the business will grow to the point where her share of equity is large enough to reach her financial goals and repay the loan with zero problems. Other questions deal with this topic, but solely for borrowing to invest in stock markets/etc. What about for business ventures?

The difference here would be that the loan is to invest in another or other businesses, not one's own.

The deal is to invest and get a guaranteed equity stake, and hope the company performs better and increases its profits/revenues. I guess the investor could help run the business as well, but that's for another discussion. In general, what is the word on borrowing to invest in a venture for equity?

It's clearly a risk, but is it any different than investing in your own business? I don't think so, but...?

Answer 1

It's clearly a risk, but is it any different than investing in your own business?

Yes, it is different. If you own a business, you determine the path of the business. You determine how much risk the business takes. You can put in extra effort to try to make the business work. You can choose to liquidate to preserve your capital.

If you invest without ownership, perhaps the founder retains a 50% plus one share stake, then whomever controls the business controls all those things. So you have all the risks of owning the business (in terms of things going wrong) without the control to make things go right. This makes investing in someone else's business inherently riskier.

Another problem that can occur is that you could find out that the business is fraudulent. Or the business can become fraudulent. Neither of those are risks if you are the business owner. You won't defraud yourself.

Angel investing, that is to say investing in someone else's startup, is inherently risky. This is why it is difficult to find investors, even though some startups go on to become fabulously wealthy (Google, YouTube, Facebook, Twitter, etc.). Most startups fail. They offer the possibility of great returns because it's really hard to determine which ones will fail and which will succeed. Otherwise the business would just take out the same loan that Jane's getting, and leave Jane out of it.