When Tina McGonagill wanted to expand her food container business, she took on an investor she met at a trade show.
For $50,000, she gave Trent Lowenstein a 20% stake in Big Fat Lunch. Yet before she spent the money, the two were at odds over the best strategy to increase profits.
McGonagill wanted to order more stock and was hoping Lowenstein would use his charismatic personality to get the product into retail stores.
“Without stock we have no business, because at the end of the day when you own a product your biggest priority is to get into retail,” she told CNBC’s “Money Court.“
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Lowenstein, on the other hand, wanted to turn to social media and influencers to increase direct-to-consumer sales. With lower margins, there is increased profit on each product sold, he argued.
The dispute shows the importance of having a smart governance structure, such as a board, and understanding the rights an investor has in company decisions, said Michael Goldberg, executive director of the Veale Institute for Entrepreneurship at Case Western Reserve University.
“If you’re an entrepreneur managing a small business, dealing with investors and their input can be really time-consuming and counterproductive,” he said.
When adding an investor, be sure to clearly understand how much of a stake they’ll have in your company. In the case of McGonagill and Lowenstein, she only gave up 20%. That means Lowenstein didn’t have a controlling interest and couldn’t direct how the money was to be used.
Networking comes first
Even before you are ready to take on an investor for your small business, Goldberg suggests first building and maintaining a network. If you engage with people before you have an ask, it sets the stage for when you are ready.
“Oftentimes, early investors come from friends and family,” he said. “It is also folks that you know through your high school, through your university, your business school or professional associations.”
In addition, turn to mentors who can give you advice on your journey. In fact, they may be more helpful in the early stage than getting a lawyer or investment banker, Goldberg noted.
While crowdfunding platforms like Kickstarter may also be a good way to raise capital, angel investors and venture capitalists are more expensive and tend to be more for technology-based companies than Main Street businesses, Goldberg said.
“The expectation when you take in venture and angel investors is that it is going to grow very quickly and those investors need their monkey back at a higher multiples than they gave it to you,” he said. “That can occur through a sale of a company or an [initial public offering].”
McGonagill decided to hold off spending the majority of her investor’s money. The two eventually reached a compromise, courtesy of O’Shares ETFs chairman Kevin O’Leary, who presides over “Money Court.”
He directed McGonagill to give Lowenstein $10,000 to prove he can sell the product direct-to-consumer profitably. If it works, he said, the company should invest more money.
“Retail will come to you after you have proven it multiple times direct-to-consumer,” O’Leary said.
TUNE IN: CNBC’s “Money Court” featuring Kevin O’Leary airs Wednesdays at 10 p.m. ET.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.