Should You Invest in an Experienced Businesspersons New Business

Here's another example of a businessperson who was seeking investment money in a new business. Eddie was someone Lisa knew as a very active note buyer. He had been buying seller-financed mortgages at a discount as a business for many years. A few years ago, Eddie decided to expand his horizons and start teaching his business concept to others. He developed a business called The Note School, which was intended to provide education and mentoring to people who wanted to learn how to invest in seller-financed notes that were secured by residential real estate. Eddie connected with an infomercial guru, he developed his speaking and teaching skills, and he started going around the country speaking professionally about his area of expertise.

Eddie's goal in this new business venture was to teach people how to find these deals, at which point they would bring the deals to him. He would do all the due diligence, and then he would be the broker in the middle and sell the deals to funding sources. Unfortunately (as we all now know), the real estate market changed because of the subprime mess and the tightening in the lending arena, so very few lenders were offering private seller-financed mortgages anymore. The lenders had become extremely cautious because too many buyers had obtained seller-financed mortgages two years earlier when interest rates were low and anybody could get a loan and didn't pay them back.

Eddie's new business was going really well, but then the borrowing scene changed and there were no funding sources to tap. He found himself in a situation in which people didn't see an opportunity in his teaching them to be bird dogs to find new investing opportunities from seller-financed mortgages. So he needed a new way to continue to support himself. He decided to try to develop other alliances and work with other types of cash flows and develop a school for all alternative cash flow investing. He wrote a business plan that described how he would do that.

In Eddie's favor, he had a history of being successful with The Note School. In addition, he had put together some products, including books, tapes, and DVDs, that he could sell and would be a profit center. He also started working with some associations to get his foot in the door and capitalize on the concept of teaching people to become self-sufficient in money matters and become entrepreneurs in the alternative cash flow industry. With all this as background, Eddie approached Lisa and asked if she would like to be a funding source for him if he were to get this new business off the ground. And Lisa would because Eddie has 25 years' experience in the business, and he is a very well connected, honest, and ethical person.

But if he were to approach you to invest in his business, and you didn't know all this, you would need to decide whether you were interested in making him a private loan. How would you know if he's honest? Is this somebody you've known for a long time? You have to decide if you're willing to take that risk. After all, Bernie Madoff had 25 or more years of experience in his business, and his clients believed that he was knowledgeable, successful, honest, and ethical — until he confessed that his business was just a giant Ponzi scheme, and he had defrauded all the people who gave him money to "invest," which he spent instead of investing. Just as with Bernie Madoff's business, if you decide to invest in Eddie's business, that investment is unsecured because he has no collateral (just as Bernie Madoff had no collateral).

Whether to invest in Eddie's new business is really the same as deciding whether to invest in Rita's catering business because it's an intangible business, and the only collateral is Eddie himself. If Lisa believed enough in Eddie's idea, and if she thought his business plan was strong enough, and if the term of the money that Eddie needed and that Lisa invested was short enough, Lisa would consider investing in his business. She would use her IRA because she doesn't need her IRA money right now. She wouldn't invest any of her personal money if she needed to live on it because for her the investment is too risky.

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