Small business owners are essential to the fabric of the U.S. economy, creating millions of jobs and providing identity to the communities they serve. According to the U.S. Small Business Administration, small businesses have created 12.9 million net new jobs over the past 25 years, accounting for two-thirds of the jobs added to the economy. Small businesses keep local economies healthy and vibrant by fostering entrepreneurship and innovation.
Despite these benefits, many small and medium-sized businesses often lack capital to sustain and expand their operations and rely on local investors to raise the capital they need to grow. Investing in small businesses offers potential profits, diversification, and the opportunity to participate in the success of the American economy.
This handy guide explains how individual investors can strengthen their portfolios by investing in local companies.
Small businesses invest based on numbers.
- According to the U.S. Small Business Administration, small businesses have accounted for 66% of job growth over the past 25 years.
- Research by the advocacy group 3/50 Project shows that for every $100 a customer spends at an independent store, $68 is returned to the community through taxes, payroll and other costs. By comparison, spending $100 at a national chain only leaves him with $43 in the community.
- According to the U.S. Chamber of Commerce, there are 32.5 million small businesses in the United States, accounting for 99.9% of all businesses.
- According to Dataman Group, small businesses employ about half of the U.S. private sector workforce.
- According to a 2020 survey by Union Bank, 72% of Americans say supporting small businesses is more important than getting the best deal elsewhere, and many respondents prefer products from independent shops. respondents said they would be willing to spend $20 more.
- The nonprofit organization SCORE reveals that 91% of Americans shop at a local store at least once a week, and 47% frequently shop at a local store two to four times a week. Did.
How to invest in small businesses
Whether you're looking to finance a new business or take ownership of an existing one, there are usually two main options.
- stock investment Involves offering money in exchange for a share of a business. Through this approach, you become an owner of the company, share in profits or losses, and even participate in management decisions.
- debt investment A loan given to small business owners in exchange for interest for a predetermined period of time. The entrepreneur maintains full ownership of the business by agreeing to repay the balance plus interest.
While each deal is unique and may involve a combination of equity and debt, these two principles are the basis of most deals. However, like any investment, each option has its pros and cons.
stock investment
| Strong Points | Cons |
|---|---|
| High profit potential | If the business fails, you may lose your entire investment. |
| May be related to business strategy | What is the final payment in case of bankruptcy? |
| can receive dividends | high risk |
debt investment
| Strong Points | Cons |
|---|---|
| less risky than stocks | If the business is doing well, the upside will be limited. |
| prescribed interest rate | Limited ability to influence strategy |
| If the business fails, you may be able to recover some or all of your investment. | Returns may not be able to exceed inflation |
Apart from the motive of making someone's dream come true, many investors choose to invest in small and medium-sized businesses to generate passive income and diversify their assets outside of the stock market and real estate holdings. Ownership allows investors to be involved in a company's strategy while also potentially adding value to the local community.
Who can invest in small businesses?
Investing in small and medium-sized businesses has long been the preserve of accredited investors, or individuals with a net worth of at least $1 million (excluding their primary residence) and an annual income of $200,000 or more in each of the past two years, with high expectations for the future. has been limited to only. Those who continue or hold certain investment licenses. Depending on the transaction, federal regulations barred retail investors from accessing what authorities deemed high-risk investments.
However, the Jumpstart Our Business Startups Act (JOBS Act) of 2012 lifted some restrictions, allowing individual investors over the age of 18 to invest in crowdfunding platforms such as Mainvest and Honeycomb Credit. Both startups vet small business owners and provide access to credit.
Nevertheless, due to regulations, most investors can only invest up to $2,500 or 5% of their annual income in a 12-month period if their annual income or net worth is less than $124,000. For high-income earners, the cap jumps to 10% of annual income or net worth, whichever is higher. There are no investment restrictions for accredited investors.
The Securities and Exchange Commission periodically adjusts these limits based on inflation.
Financing options for small businesses
Small businesses have a variety of options when it comes to financing their business. These include crowdfunding, friends and family, small business loans, grants, bootstrapping, angel investors, and venture capital.
Questions to ask before investing in a small business
Investors should perform due diligence when selecting potential investments because small businesses are susceptible to economic changes, overhead costs, changes in supply and demand, and other circumstances. One of the benefits of investing through crowdfunding platforms is that these companies will do much of the preliminary work for you, such as checking your tax returns, credit score, and other important documents.
There are several questions to consider before making an investment decision.
Of course, there are many other things to consider, including invisible ones. For example, what is the small business owner's story and what value does the business bring to the community? For many investors, investing in small businesses goes beyond the financial element, but , don't get so caught up in the story that you forget you're making a financial investment. When it comes to investing, it's not a good idea to act emotionally.
Risks of investing in small and medium-sized enterprises
All investments involve varying levels of risk, and small businesses are no different. Aside from potentially losing your entire investment, these transactions are inherently risky, especially since many entrepreneurs are ineligible for funding from traditional banks. Therefore, many financial experts recommend investing only the amount you can afford to lose.
To compensate investors for that risk, the target return could range from 10% to 25%, according to crowdfunding platform MainVest.
According to the Small Business Administration, about half of small businesses fail within five years, making them one of the riskiest investments. Many small businesses start their businesses in industries with low barriers to entry, such as retail or restaurant industries. This results in a highly competitive environment with low profit margins and frequently changing customer preferences.
Additional small business resources
If you have further questions about investing in small businesses or are looking to develop an overall investment strategy, consider finding a financial advisor to discuss your personal financial situation. Below are additional resources to help your small business invest.
Editorial Disclaimer: All investors are encouraged to conduct their own independent research on any investment strategy before making any investment decisions. Additionally, investors should note that past performance of an investment product does not guarantee future price appreciation.
