Investing in Small Businesses

The most common layperson’s idea of “investing” is perhaps stocks and bonds, but the world of investing does, of course, include much more than this. Along with real estate, peer-to-peer lending, and liquid assets like gold, you can invest in a small business. While this can be a risky maneuver, it also has the potential for lucrative growth.

Providing capital

Two of the top ways to invest in a small business are equity investments and debt investments. In both of these cases, you help provide the capital to get the business going or to help it expand. Sometimes the people who provide these funds are known as “angel investors.” An equity investment is the type of investment you make when you “buy in” to a company. This means you provide some sort of capital in exchange for a certain percentage of profits or losses (think Shark Tank). Equity investments have the potential for the most gain–the largest classification of US millionaires is the self-made business owner. A debt investment, on the other hand, means that you loan money to the company, which in turn will pay you interest income in addition to paying back the original amount. Debt investing allows you a little less risk, because if the business fails, you will probably have collateral, such as a lien on the property, which you can take.

Venture capital or angel investing?

When it comes to providing capital to a small business, investors go one of two ways: either through venture capitalism or angel investing. Venture capital funding usually happens with a whole group of people (maybe a firm), and it focuses on businesses with high growth possibility. These investors are able to have a say in how the company is run. A venture capitalist may not choose to provide funding to a company until that company has been running for a while. An angel investor, on the other hand, provides startup capital to the company. If you’re an angel investor, don’t expect to make any money. Angel investors can include friends and family, or they can be wealthy individuals who believe in the business or entrepreneur. They may make an equity or debt investment.

Along the same lines as angel investing is seed investing. (In fact, angel investors are a type of seed investor.) Seed investing is the initial capital it takes to get a business started and the investing during the earliest stages of a company’s existence. Seed investments often comes from the person starting the business and his or her families, but it may also include financial experts who have done their due diligence. For the layperson, there are lots of companies that help you invest in your favorite vetted startups via crowdfunding.

Risks

There’s a high chance that a small business will fail; in fact, 90% of startups do. No matter what, you should expect to lose money, at least initially. You shouldn’t expect a return on your investment for at least 10 years. If you are an equity investor, and the business experiences losses, you also take on some of the losses. You can ameliorate this risk potential by lending, rather than buying in to the company.

You can also lower your risks by doing your research. How well-run is the business? It doesn’t matter how good an idea is if it can’t be managed well. Ask the business how much money they’ve already raised–this is a good indicator of how well the company is already running– and calculate how much your investment is consequently worth. Be sure to read all the legal documents you can get your hands on. (Again, how well-organized all their paperwork is is an indication…) See how the company is incorporated, how the shares are issued, and whether or not they are working with an attorney.

Diversity is key. Rather than putting all your eggs in one basket, spread out your investments across several businesses. You might not win as much, but you won’t lose as much either, and positive income is always better than negative! Do your research. Do you feel that this new product or service is essential? Is it filling a necessary role? Perhaps it’s effectively capitalizing on a trend, such as offering online vape deals to a growing market, which means they also reach people who partake but who don’t live near a vape store. Perhaps they have a new angle on SEO strategy. Additionally, take a look into the who of the business, because that’s just as, if not more, important than the business idea itself. Look for who is founding each company. Is the company under strong leadership?

If you have a smaller budget.

Perhaps you’re not looking to get rich. You may be one of the many Americans who, as a matter of principle, wants to promote up-and-coming businesses over established major corporations. Or you may want to dabble in startup investments in a safer way before putting a lot of money towards something. Prior to May 2016, anyone who wanted to provide capital to a new businesses had to have a net worth of $1 million, or earn $200,000 a year. Title III of the JOBS Act eradicated that, and now anyone can invest in a startup. One easy way to invest in a smaller venture is through crowdfunding. Platforms like Crowdfunder and Indiegogo provide platforms for this. There are plenty of other platforms out there, too. Use these, especially if you’re a first-time investor, because they can walk you through the process of providing equity and getting returns. They have also probably vetted the projects on their platforms.

Is it for you?

Investing in small businesses isn’t for everyone. Even if you do decide to buy in to a start-up or small store, it’s always wise to have a diversified investment portfolio. For more stability, you may opt to invest in large-cap stocks, which are basically the most frequently-traded stocks on the market. To go this route, look into swing trading strategies, similar to what investor Jesse Livermore used to trade. You can participate in swing trading without having to make it your whole day job. You can also do this in addition to making an investment in a small business.

 

Adam Torkildson