Investing in small business can be a great way to diversify your portfolio and support local communities. But, like any investment, it also has risks.
Investors can choose from two types of investments in small businesses: equity (buying into a company and sharing profits) and debt. Both involve thorough vetting, including reviewing financial statements and interviewing management.
Equity Investments
When you invest in a small business, you buy a stake in that entity and become a partial owner. This allows you to participate in decision-making and earn money based on the company’s profits or revenue. You also receive tax benefits for your investment.
Investors in a small business may provide essential management or technical skills, contacts or networks, and reputation along with capital. This is known as equity funding, which reduces the risk for a small business compared with debt financing.
Businesses often seek investors through private equity firms or Small Business Investment Companies (SBICs) that are licensed by the SBA. These privately owned organizations use their own funds, as well as SBA-guaranteed funding, to invest in small businesses. SBICs can offer both debt and equity investments. Debt investments include a loan that the business must repay plus interest, while equity investments involve a share of ownership in the business. Both types of financing have their own unique benefits and risks for business owners.
Debt Investments
As the economy continues to improve, more and more small business owners are seeking investment opportunities. They need money for everything from startup expenses to expanding their operations. Investing in small businesses offers some unique advantages for investors and entrepreneurs alike.
Investors can use debt investments to act like a bank by lending funds to a small business and agreeing to pay interest payments over a predetermined period of time. This type of investing often produces a higher return than stocks and mutual funds. It also allows entrepreneurs to retain full ownership of their company while gaining access to capital they would otherwise be unable to receive through other financing options. For example, debt investments typically take priority over equity contributions in the event of a liquidation. This can help a small business owner avoid paying back equity contributors in the event of a bankruptcy or forced sale. The best option for each investor will depend on their individual circumstances.
Crowdfunding
Crowdfunding is a popular method for raising capital and building businesses. It involves a large group of people donating small amounts to support a project, such as a new restaurant or technology product. Crowdfunding is usually done online. This method has several benefits for both entrepreneurs seeking capital and investors.
It can lower the risk of investing in small businesses, because you are supporting projects with which you are familiar. It can also allow you to choose companies whose principles and practices align with your own, such as environmentally sustainable products or energy-efficient devices. Did you know that bizop has more information on this? Head there now!
It can be more time consuming than traditional investments, as you must evaluate business opportunities and conduct due diligence, including examining financial statements and interviewing company executives. You must also negotiate terms, such as how much to pay for equity shares or how much interest to charge for loans. It can be illiquid, as you may have to hold on to your investment for years before you can cash out.
Personal Investments
The success of a small business often requires more than just the efforts of the owner. Personal investments can be a way for business owners to grow their money and provide a safety net in the event of financial difficulties or if they choose to close their business.
Many small businesses receive their first investment from friends and family. Even Amazon founder Jeff Bezos got started by asking for money from his loved ones!
While this form of investment has a higher risk than other methods, it can also be more rewarding. Investing in a small business allows you to be more involved with the company and can help you develop a deeper connection to the brand.
Personal investments can also be a way for small business owners to grow their retirement savings. However, it’s important to work with an advisor who can offer easy and efficient strategies and help you understand the income tax implications of your personal investments.