How to invest in small businesses – Forbes Advisor

Small businesses are a key driver of the economy, accounting for nearly 63% of new jobs. And the number continues to grow. According to the U.S. Small Business Administration (SBA), 1.07 million new small businesses will open in 2023.

Even if you don't want to start your own business, you can invest in a business and benefit from its role in the economy. Investing in small and medium-sized businesses is a great way to support entrepreneurial growth and diversify your investment portfolio.

However, investing in small businesses can be risky, so it's important to understand the risks and diversify your investments.

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How to invest in small businesses

Financing is a major concern for business owners. According to a 2023 Goldman Sachs survey, 77% of small business owners said they were concerned about the availability of capital. Therefore, funds from everyday investors can help owners and entrepreneurs start new companies, expand their operations, and hire employees in their communities.

When investing in small and medium-sized businesses, your investment can be in one of the following forms:

• stock investment: In equity investing, you buy part of a business. You become a part owner. In some cases, you have a say in how the company is run and its future direction. If your business is doing well, you can make a profit by taking a portion of the profits or selling your shares at a higher price.
• Debt investment: When you make debt investments, you act like a bank. When a company lends a certain amount of money, it usually agrees to repay that money with interest.

You don't have to be on “Shark Tank” to invest in small businesses. There are several ways to become an investor.

1. Angel investor group

Angel investors are the largest source of funding for small businesses. Angel investments in the United States in 2022 totaled $22.3 billion.

Angel investors are usually wealthy individuals who invest in small and medium-sized businesses. They may join an angel investor group, which is made up of multiple investors who come together to evaluate and invest in businesses.

To join an angel investor group, you typically need to be an accredited investor. This means it must meet the standards outlined by the Securities and Exchange Commission (SEC). Accredited investors must meet certain criteria, including:

• Annual income of more than $200,000 ($300,000 if married)
• Net worth over $1 million
• Certain specialized financial qualifications, such as the General Securities Representative License (Series 7) or the Investment Advisor License (Series 65)

Some angel investor groups target companies in specific regions, such as the North West, or specific demographics, such as women-led businesses.

You can find an angel investor group near you through the Angel Capital Association database or the Angel Investment Network.

2. Crowdfunding platform

Angel investors tend to have high net worths and incomes, so joining an angel investor group may not be practical for most people. If your income or net worth is low, it may be easier to invest in small businesses through crowdfunding platforms with loose participation requirements.

These platforms connect small business owners in need of capital with investors. You can invest as little as $100 in a single company and choose companies to invest in based on mission, industry, and location. Popular crowdfunding platforms include:

• Main best: Mainvest carefully vets companies that apply for funding through the site. The company says only 5% of companies that apply for funding support make it onto the list. When you invest, you are usually paid back quarterly, but returns are not guaranteed. Mainvest's minimum investment amount varies by project, but is typically around $100.
• Microventure: Microventures allows you to invest in startups for as little as $100. However, unlike other sites, Microventures also allows secondary trading, allowing you to sell your late-stage private equity to other investors.
• Weefunder: With WeFunder, you can invest in a variety of companies, from tech startups to your local coffee shop. You can invest as little as $100.

3. Word of mouth and networking

Investing through word of mouth and networking is a less formal approach, but it is one of the most common forms of small business investment. In fact, according to a study published by Clutch.co, 22% of entrepreneurs received funding from friends and family within their first three months after starting a business.

If your friends, family, or colleagues are starting a business, you can invest money to help them get their dreams off the ground. However, this type of investment requires a great deal of trust.

If you pursue this route, be sure to do your due diligence on the business' plans, operations, and prospects. Next, you need to draw up a repayment or capital agreement.

Benefits of investing in small and medium-sized enterprises

Investing in small businesses has many benefits.

• Higher earning potential: Investing in small businesses can give you higher returns than investing in the market. The average expected return for most of Mainvest's products is between 10% and 25%.
• Support brings you meaning: You can choose companies and founders whose principles and practices are important to you. For example, you can invest in companies that align with your goals, such as companies that develop sustainable products or energy-efficient devices.
• Improved control: When you invest in the stock market, you become a shareholder, but you don't have a say in how the business is run. However, if you want to invest in a small business, you can become a part owner. If the stakes are big enough, you can help shape the future of your business.

Risks of becoming an investor

Investing in small and medium-sized enterprises is attractive because of the high potential returns. However, there are some significant drawbacks to keep in mind.

• Your business may fail: It is very difficult for small businesses to survive. According to the U.S. Bureau of Labor Statistics, only 47.1% of businesses founded in 2017 were still operating in 2023. The numbers are even more dire for older companies. Only 28.8% of businesses that opened in 2010 were still operating in 2023.
• You can lose money: Although investment platforms advertise high return potential, it is important to keep in mind that returns are not guaranteed. Also, past performance does not guarantee future returns. There is a high rate of businesses failing or struggling to break even, so there is a good chance you will incur losses.
• scam: Like any investment opportunity, business investing has the potential for fraud. Watch for red flags such as guaranteed returns, representatives claiming to be part of a major company, or high-pressure tactics to induce investment.

How much to invest in small businesses

When thinking about how much to invest in a small business, keep in mind that there are limits to how much you can invest. If you want to use an equity crowdfunding platform, there are strict regulations that you must follow.

Due to the risks involved, the following investment restrictions apply.

• If your annual income or net worth is less than $124,000, you can invest up to $2,500 or 5% of your income or net worth, whichever is greater, in a 12-month period.
• If your annual income and net worth are each more than $124,000, you can invest 10% of your income or net worth, whichever is greater, up to $124,000.

Here are some examples:

The only way to contribute more through these platforms is to become an accredited investor. There is no upper limit on the amount you can invest as long as you meet the criteria.

Funding for startups and small businesses

Investing in small businesses can be beneficial. It has the potential to be highly profitable and allows you to support businesses in your local community and businesses that align with your interests and values.

However, investing in small businesses comes with risks. It's important to understand the risks and take steps to protect your finances. Investing in small and medium-sized businesses should only make up a prudent (and probably relatively small) portion of your overall investment portfolio. Diversifying into other investments, such as the stock market, index funds, or real estate, can help offset losses over time.