It should be pretty obvious that without knowing what sort of assets the company owns, and what sort of net earnings are being generated it's impossible to say what a $20k equity investment should get you in terms of ownership percentage.
With that said, you want to look at a few to several years of books, look for trends. Some things to understand that might be subtle red flags:
- Who are the clients?
- What percent of revenue are the top 5 clients?
- Assuming there are more than 5 clients.
- Is the revenue cyclical?
- How much has the owner invested?
- Are there other investors?
- Does the business have any debt?
- What will this $20k accomplish?
- Is this will be for new hires, how will that person be found? What are they going to do? What will they be paid?
- Is this for equipment?
- Is this money simply going in to the owner's pocket in exchange for some percentage of future cash flow?
- Is this business a "real" business?
- Business license, business tax returns, bonded, insured, etc.
It's extremely common for early stage investors to essentially make loans rather than strictly buying shares. In the worst case scenario creditors get to participate in liquidation proceedings before shareholders do. You may be better off investing in this business via a loan that's convertible to equity at your discretion.
Single owner service companies are difficult because all of the net earnings go to the proprietor and that person maintains all of the relationships. So taking something like 5 years of net earnings as the value of the company doesn't make much sense because you (or someone else) couldn't just step in and replace the owner. Granted, you aren't contemplating taking over the business, but it negates using an X years of net earnings valuation method. When you read about valuation there is a sort of overriding assumption that no single person could topple the operation which couldn't be farther from the truth in single employee service companies. Additionally, understand that your investment in a single owner company hinges completely on one person's ability and willingness to work.
It's really vital to understand the purpose of the funds. Someone will be hired? $20,000 couldn't be even six months of wages... Put things in to perspective with a pad, pen and calculator. Don't invest in the pipe dream of a friend of yours, and DEFINITELY don't hand this person the downpayment for their new house. The first rule of investing is "don't lose money," this isn't emotional, this is a dollars and cents pragmatic process.
Why does the business need this money? How will you be paid back?
Personally, I think it would be more gratifying to put $20k in a blender and watch it blend, this is probably a horrible investment. The risk should just be left to credit card companies.