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3 Steps for Turning Customers Into Investors

Can't get a bank loan? Customers and community members can be your best investors. Here's how to make that happen.
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Zak Cassady-Dorion wanted to aggressively expand Pure Mountain Olive Oil, his gourmet olive oil business. When the bank denied the loan he needed to open a second shop, he found a better backer: loyal customer Wolfgang Foust.

Foust, who grew up in Spain with olive trees in the backyard, routinely traveled 70 miles to shop at Pure Mountain's inaugural Rhinebeck, N.Y., store, which opened in May 2012. Foust invested $10,000 in Pure Mountain in exchange for a small piece of equity. That August, Cassady-Dorion was able to open his second shop in Tarrytown, just miles from Foust's home.

"It was a real testament to what we were doing that he wanted us to open up a shop closer to him," Cassady-Dorion says.

Today Pure Mountain is thriving, selling premium olive oil, vinegar and sea salt in three retail locations as well as online, wholesale and through home-selling and corporate-gifting programs. Cassady-Dorion estimates business has grown 550 percent since 2013. Foust, a former produce trader, joined the company as COO and general manager when the Tarrytown store opened.

Enthusiastic customers and community members make great investors, says Mike Moyer, a serial 'trep who teaches entrepreneurship at Northwestern University and the University of Chicago Booth School of Business. "They're the ones who'll spread the word about your business," he says.

Of course, there's more to scoring capital from community cheerleaders than mentioning you're looking to expand and sussing out whether they have money to burn. Here's what you need to know.

Accept investments, not loans. Moyer cautions against personal loans when accepting money from a neighbor: "For small money--under $50,000--I always point people toward a convertible loan or convertible equity note." That way, he explains, if the company goes under, there's no expectation of repayment.

Get it in writing. Don't rely on a handshake; there's too much room for disagreement later. Don't fly blind when creating a contract, either. "If you don't have a really good understanding of what equity is and how it works, have somebody else who is more experienced take a look," says Cassady-Dorion, who tapped his financial advisor for contract help.

Set the level of involvement. Most people who make a modest investment in your company won't become a senior executive like Pure Mountain's Foust. To discourage investors from acting like one, set boundaries early. "It's important they know that you have the control," Cassady-Dorion says. "If they have 2, 3, 4, 5 or 10 percent equity in your company, you don't want them calling you up and telling you how to run your business every other day."

How much is it worth?

A quick guide to pricing equity stakes from entrepreneurship
professor Mike Moyer

1 Give yourself a pre-revenue valuation of $1 million. For new companies in nearly any business, this is a safe place to start: not so high that you scare off investors, and not so low that you sell yourself short.

2 Receiving a $50,000 investment bumps up your valuation to $1,050,000, therefore the equity on that investment ($50,000/$1,050,000) = 4.76 percent.

3 If stumped, seek advice from business mentors, advisors and peers who've been there.

4 For contract help, get referrals for a startup lawyer near you who offers "startup rates" and has structured startup equity deals before.