Frank decided to accept a business proposition from his friend Chike after weeks of pitching from the latter. Chike was an experienced trader and had been successful in making money for Frank in previous deals they had done. Frank gave Chike a sum of N5million for the business with a promise to get a profit of N2million at the end of the 12 months.
It’s two years now and Frank has only been paid N500,000 from the N5million given to Chike, far short from the N4million (interest only) he should have received based on the promise of a 40% return. Having exhausted his patience, Frank requested for his capital of N5million which Chike apparently has unfortunately been unable to provide as well.
Their relationship has gone south since this deal failed to materialised as planned, and every avenue of reaching a financial truce has been exhausted. Frank is unrelenting and has demanded that Chike give him back his money and nothing less.
A commonplace scenario
Stories like this are not uncommon in Nigeria and in fact do happen everyday between people who you think should know better. Feuds like this can be avoided if only people knew the implication of parting away with their money unwittingly. An investment in a business is akin to putting equity into a company.
For example, If I am approached by someone to invest in a business and I ended up parting with some money in return for profit, then that money I parted with is more like an equity investment. As we mostly know Equity Investments are only secured by your shareholding in a company even if you weren’t offered shares.
[Also Read: 10 Mistakes to avoid for Start-Ups]
Investor vs Lender
Though, it can be argued that since I did not receive shares my money should be seen as a loan. I will therefore like to use the story of Frank and Chike to properly highlight the difference between an investor and a lender.
Case study 1:
If the money given to Chike by Frank was a loan and not represented by shares nor any collateral;
In this case the amount given to Chike is an unsecured loan and can only be paid by Chike depending on his financial ability. Usually, the Police settle cases like this out of court by asking the debtor to decide how much he can pay periodically. So if Chike says he can pay N1,000 every month till he finishes then that is it.
If Frank doesn’t accept then he can proceed to the courts which might take forever to decide. This scenario can be proven as a loan even if the agreement did not specifically refer to it as neither a loan or an investment. However, Frank may never get back any interest.
However, if the agreement was worded in such a way to suggest that Frank gave the money to Chike based on a partnership or collaboration then it is an investment and Frank may just immediately consider that money a bad debt which is likely lost.
Case study 2:
If the Money Chike received from Frank was secured by an asset;
If this is the case then that specific asset or assets will be sold to recover the money that will be paid back to Frank. The problem, however, is that the money may not be enough to which case the Judge or whoever is handling the case may ask that another asset be provided.
A bigger problem even is that if the asset(s) is already registered by the state in favour of another person or persons (creditors) Chike is owing, then consider that the person(s) will have to be paid first before Frank receives his money. Regardless of the above, I still consider the debt in this scenario an unsecured one especially if the asset(s) is not registered. This scenario is, however, Lending in my view.
Case study 3:
If the money was given to Chike in exchange for shares;
This is purely an investment and as such the money Frank gave Chike is his equity contribution to the business. His recourse to his money will probably be a sale of any remaining assets the company may have. If there is none, then he may just consider his investment lost for ever. Chike is not obliged to pay Frank any money back.
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Understanding investment
- Who is an investor?
- What does an investor stand to gain?
- What is the downside of being an investor?
- How shares works in investments
- Manners of recovering funds by an investor
If an investor typically parts away with his money in the form of equity in a business; in return -he gets to be an owner of a business, receives dividends from the profits declared by the company, receives value appreciation in his investment if he decides to sell his shares at a higher value etc.
An investor cannot expect to get interest payments or refund of his capital in a business. He can only get refund of his capital by either selling his shares or if the company decides to go into voluntary liquidation and shut down.
The Lender’s Equation
A lender, however, expects to get back his capital along with interest as specified in the contract. However, the degree to which a lender is able to recover their money in the case of default by the borrower will depend on how strong the collateral or security he posses against the borrower’s assets.
The Lender is even in a more precarious situation if they have no collateral or security. In this instance they may never recover their debt should the borrower remain unable to pay.
[See: 10 Mistakes to avoid for Start-Ups]
Updated on July 15, 2019: This story was published at an earlier date and has been revamped to educate our readers on the subject.
