Small businesses play a crucial role in driving the economy, accounting for nearly 63% of new jobs. With the number of small businesses on the rise, investing in them can be a smart move. Not only does it support the growth of entrepreneurs, but it also diversifies your investment portfolio. However, investing in small businesses comes with risks, so it’s important to understand them and diversify your investments.
Ways to Invest in Small Businesses
Funding is often a concern for business owners, with 77% of small business owners expressing worries about the availability of capital. Investing in small businesses provides an opportunity to help owners and entrepreneurs launch new companies, expand operations, and hire employees in their communities. There are two main ways to invest in a small business:
- Equity investment: With an equity investment, you become a partial owner of the business. You may have a say in how it’s run and its future direction. If the business succeeds, you can profit from its profits or by selling your stake at a higher price.
- Debt investment: With a debt investment, you act as a lender. You provide a specific amount of money, and the business agrees to repay it with interest.
Don’t worry – becoming an investor in a small business doesn’t require you to appear on “Shark Tank.” There are several avenues you can explore.
1. Angel Investor Groups
Angel investors are a significant source of capital for small businesses, with angel investments in the U.S. totaling $22.3 billion in 2022. Angel investors are typically high-net-worth individuals who invest in small businesses. They often participate in angel investor groups, which comprise multiple investors who evaluate and invest in businesses.
To join an angel investor group, you usually need to be an accredited investor, meeting specific criteria outlined by the U.S. Securities and Exchange Commission (SEC). These criteria may include having an annual income exceeding $200,000 (or $300,000 if married), a net worth exceeding $1 million, or certain professional financial credentials.
Some angel investor groups may target businesses in specific geographical areas or specific demographics, such as women-led businesses. You can find angel investor groups near you through databases like the Angel Capital Association or the Angel Investment Network.
2. Crowdfunding Platforms
Angel investors often have high net worths and incomes, making joining an angel investor group inaccessible to some. If your income or net worth is lower, investing in small businesses through crowdfunding platforms can be a more viable option. These platforms connect small business owners in need of capital with pools of investors. You can invest as little as $100 and choose which companies to invest in based on their mission, industry, or location.
Some popular crowdfunding platforms include:
- Mainvest: Mainvest carefully vets businesses applying for funding through its site. They list only 5% of businesses that seek help in raising capital. Minimum investments vary by project but are typically around $100.
- Microventures: With as little as $100, Microventures allows you to make equity investments in startups. It also allows secondary trading, giving you the option to sell late-stage private stock to other investors.
- WeFunder: WeFunder lets you invest in various companies, from tech startups to local coffee shops. The minimum investment is $100.
3. Word of Mouth and Networking
Investing through word of mouth or networking is a less formal approach but is one of the most common forms of small business investing. In fact, a study found that 22% of business founders received funding from friends and family within the first three months of starting their business.
If you have a friend, family member, or co-worker starting a business, you can invest money to help them get their dream off the ground. However, this type of investment requires a significant amount of trust. Before investing, be sure to thoroughly research the business’s plan, operations, and outlook. It’s also crucial to create a repayment or equity agreement.
Benefits of Investing in Small Businesses
Investing in small businesses offers several benefits:
- Potential for higher returns: Small businesses can provide higher returns compared to traditional market investments. For example, on Mainvest, the average projected return of most offerings is 10% to 25%.
- Supporting meaningful causes: By investing in small businesses, you can choose to support companies and founders whose principles and practices align with your values. For instance, you can invest in businesses that focus on sustainability or energy efficiency.
- Increased control: Unlike investing in the stock market, investing in a small business can grant you a greater degree of control. As a partial owner, you may have influence over the business’s direction and future.
Risks of Becoming an Investor
While investing in small businesses offers the potential for high returns, it comes with its own set of risks:
- Business failures: Small businesses face significant challenges, and many fail to survive. According to the U.S. Bureau of Labor Statistics, only 47.1% of businesses launched in 2017 were still open in 2023. For older companies, the survival rate drops even further.
- Potential loss of money: While investing platforms may advertise high potential returns, there are no guarantees. It’s crucial to remember that past performance does not guarantee future returns. With a significant percentage of businesses failing or struggling, there is a risk of losing money.
- Fraud: As with any investment opportunity, there is a potential for fraud. Look out for red flags such as promises of guaranteed returns, representatives claiming affiliation with major firms, or high-pressure tactics.
How Much to Invest in a Small Business
When deciding how much to invest in a small business, it’s important to consider investment limits and regulations. Equity crowdfunding platforms have strict regulations that must be followed. Here are the investment limits:
- If your annual income or net worth is less than $124,000, you can invest up to $2,500 or 5% of your income/net worth (whichever is greater) over a 12-month period.
- If your annual income and net worth are each equal to or greater than $124,000, you can invest up to 10% of your income/net worth (whichever is greater) up to $124,000.
Suppose you wish to contribute more through these platforms. In that case, you may need to become an accredited investor, meeting specific criteria that remove the cap on how much you can invest.
Funding Startups and Small Businesses
Investing in small businesses can be a rewarding experience. It offers the potential for high returns and allows you to support businesses that align with your interests or values. However, it’s essential to remember that investing in small businesses carries risks. To protect your finances, only allocate a cautious portion of your overall investment portfolio to small business investments. Diversifying your investments across other sectors like the stock market, index funds, or real estate can help balance any losses in the long run. So, go ahead and start exploring the exciting world of investing in small businesses!
