Investing in large, publicly traded companies is pretty easy to do — you simply need to purchase stock through the available exchanges. But investing in small businesses can be less intuitive. However, there are ways you can financially support local small businesses to help them grow and thrive. And not only can this investment help the business, but it can also pay off handsomely for you.
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“Investing in small businesses can be an excellent way to increase your wealth and diversify your assets,” said Kristie R. Adams, CPA, senior tax manager for Buckingham Advisors, an RIA in Dayton, Ohio. “Small businesses could give higher net returns than publicly traded companies.”
Here are the two main ways you can invest in a local small business.
One way to invest in a small business is to lend capital.
“When you lend capital in the form of a loan, you will be repaid the principal plus interest at a stated rate,” Adams said.
With this form of investment, the payoff is the interest you will get paid back. However, there are some downsides to this type of investment.
“If the company becomes insolvent, you could be stuck with a worthless debt, losing your investment. Legal action would be needed to help in trying to recoup some of these funds,” Adams said. Another downside is that “with debt financing, you do not have any ownership or control of the company.”
Invest in the Equity of the Company
Equity investing is the other option.
“You could purchase a percentage of the company’s stock,” Adams said. “In exchange for this, you are entitled to an equivalent share of the revenues and dividends paid from the business. However, you are also subject to the same percentage of losses, and sometimes debt, that the business incurs. Business uncertainty could impact the financial outcome, but it could be [an investment] worth making.”
You may purchase stocks directly from the company or through crowdfunding.
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“Equity crowdfunding platforms allow individual investors to help finance a wide variety of small businesses,” said Chris Rawley, CEO of Harvest Returns, a platform for investing in agribusiness. “These investments are structured in several ways, such as equity or convertible debt. Investors should understand how they will get their money back and when. Investing in small businesses or start-up companies can involve significant risk, but also the potential for a great payoff as the company grows.”
Which Option Is Best?
Whether you opt to invest via debt financing or equity investing depends on the level of risk you are willing to take.
“Debt financing is a lower risk method than equity investing,” Adams said. “In the event of a liquidation, debts would be paid before any shareholders are returned a portion of their capital.”
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