Investing in a small, local business is an excellent alternative to conventional investment strategies. It can produce returns several times greater than investing in a publicly-traded company. Furthermore, it serves as a contribution to the upliftment of your local economy. This blog post will explore how to invest in a local business.
Two Types Of Local Business Investments
There are two ways to invest in a small, local business: equity (exchanging money for ownership and profits) or debt (lending money). Let’s explore these in more detail:
Equity Investments
An equity investment is an ownership position or a “slice of the pie” of a business. Equity investors provide capital to the business owners in exchange for a share of the company’s profits.
Capital investment can be used for a variety of purposes, including but not limited to capital expenditures for expansion, day-to-day operating cash, debt reduction, or recruiting new personnel.
An investor’s share of the company is proportionate to the money they put in. Investing in a small, local business involves a high amount of risk. But, when things go well, the returns (which come in the form of dividends or capital appreciation) are worth it!
Debt Investments
A debt investment occurs when an investor lends money to a business in exchange for interest, income, and the ultimate repayment of the principal.
Direct loans with regular amortization (deduction of interest first, then principal) or the purchase of bonds issued by the business (which offer semi-annual interest payments delivered to the bondholder) are the most common forms of debt capital given by lenders.
The most significant advantage of debt is the special position of the creditor in the capital structure. For example, creditors take precedence over equity investors if a business fails.
How To Invest In A Local Business
There are many factors to consider to decrease your risk and increase your chances of making a profit when investing in a small, local business. If you are not sure how to get started, check out our hand-picked collection of the best investing books to learn all the tips and tricks. But for now, let’s have a look at investing factors.
Is the Business Looking for Money?
Not all businesses are looking for financial investment. For various reasons, they may not be willing to relinquish any control or be unable to make more loan payments. So, the first step to investing in a local business is finding a local business that is actively seeking investment!
Who Are the Leaders?
Once you’ve identified an investment opportunity, speak to the business leaders to understand how they plan to spend the funds they raise and what they hope to accomplish as a result. As an investor, it is vital that you trust the people who are going to be using your money to grow their business.
What is Their Financial Situation?
To make an informed decision about investing in a local business, it’s essential to take a closer look at the business plan. You can also perform background and credit checks on the owners/managers and assess whether the company has any outstanding debts.
What are the Conditions of the Agreement?
After doing your due diligence and before offering finance, you’ll need to come up with a term sheet or a draft financing agreement. First, put together a clear description of your offering, then evaluate your proposal with the business’s owners. Once you have reached a general consensus, you can focus on the specifics.
Deal Closing
To complete your investment in the company, you must close on the financing arrangement with the owners. This is the time when you’ll sign contracts and put up the money you agreed to invest.
Final Thoughts
Whether you have a few hundred dollars or a few hundred million dollars, investing in a small, local business is high risk and potentially very high reward (as well as being a very impactful endeavor). Don’t put more money into an investment than you are willing to lose, and make sure you have done your due diligence before investing!
[Disclaimer: this blog post does not serve as investment advice and was written for educational purposes only. Remember that all investments carry risk to your capital and make sure to do your own research and consult a financial advisor before making any investment decisions.]
