Investing in particular businesses can be exciting and inspirational because investors tend to choose to invest in businesses they value. There are a variety of ways to invest in businesses, but as a whole:
Investing in small businesses can involve hard work or allow you to sit on the side and just provide capital. Cash-flow businesses can diversify your portfolio, or taking a chance on an exciting new venture can just make you happy.
Similar to our real estate deep dive, this deep dive can only cover the basics of various ways to invest in small businesses beyond running with your own new idea to address an unresolved need or unseized opportunity. Some investment strategies outlined below involve less money but many hours of work, while others involve being an accredited investor but dedicating no time to business management. If any of these investment options appeal to you, explore them in more depth!
Buy Existing Businesses for Cash Flow
Buying a small, often simple, business that experiences positive monthly cash flow is a good way to get into business ownership without having a high net worth. Codie Sanchez of Unconventional Acquisitions suggests buying “boring businesses”—think laundromats or vending machines—because they have simple business models and are enduring businesses with minimal competition.
To outright buy one of these businesses, you generally need a down payment like you would when purchasing a rental property. However, there are creative options, particularly when business owners are motivated to sell. When businesses are struggling or the owner is ready to retire, revenue-share or profit-share deals can allow you to “purchase” a business without capital and provide the previous owner some of the money you create for the business.
Many of these enduring businesses have outdated processes or advertisement strategies that a new business owner can easily revamp or bolster with a few automations, some new business software, and a website. That is right: There are still many local businesses out there without a website, and those are excellent boring business purchase candidates.
If a certain type of business intrigues you, research the cash flow that is possible in the industry as well as in your area. Do your market research and see if purchasing makes financial sense for you. Then, look for a deal that meets your needs, whether you want to offer a generous down payment and take over the business completely or work with a retiring owner to structure a profit-share deal. All options are on the table, so find a deal that works for you and the seller.
Open a Franchise
If the idea of taking over a business without a guide sounds intimidating, another option is to open a franchise location. (A franchisee probably owns the Subway, Jiffy Lube, or Days Inn just down the road from you!) Opening a franchise location requires up-front costs, but it comes with training and support to ensure the standardization across franchises. By opening a franchise location, you agree to adhere to some common stipulations from corporate headquarters, but you also get to take corporate knowledge to your business processes to learn as you go.
If a franchise interests you, research the initial costs, standardized requirements, and realistic expected cash flow in your area. We all want to open our favorite restaurant down the street from us, but that is not always a realistic expectation. Run the numbers, learn about the company, and see if it is a good fit for your budget, expectations, and location.
Invest Your Money in Established Successful Businesses
If you want to invest in a specific small business or businesses in a relatively safe manner without managing the business yourself, private equity may be an appealing investment option for you. Private equity investments involve injecting capital into an existing business to foster growth, innovation, or even expansion. While private equity agreements vary, most investors prefer to have little involvement in day-to-day operations, although investors may be involved in higher-level, strategic decision-making.
If you worry about the risk involved in being an individual investor investing in a single business, private equity firms can still allow you to invest in established businesses. This limits your ability to devise your own agreement regarding decision-making since your investment is more like a mutual fund invested in established businesses. You are farther removed from the day-to-day process but can invest in multiple businesses to reduce risk. One stipulation to investing with a private equity firm is you are often required to be an accredited investor, meaning you must demonstrate that your annual income exceeded $200,000 (or $300,000 as a couple) for at least the past two years or you have a household net worth of at least $1 million (not counting your main home). (As a licensed attorney, Patrick can certify individuals as accredited investors.)
Like all investments, do your research before investing in private equity. If you plan to invest in a local business as an individual investor, review the business’s financial information before signing a deal. Discuss your involvement in detail with the current business owner(s). You do not want to find out you have more responsibility or less involvement than you imagined. If you choose a private equity firm, review their historic returns and learn how they choose which businesses to support. Make sure those businesses correspond to your values and their measurements of successful business agree with your own understanding.
Invest Your Money in the Next Big Idea
A riskier investment than private equity, venture capitalism allows you to invest in the next big idea—with the understanding that it may completely fail. Where private equity firms invest in established businesses, venture capitalist firms invest in startups without a proven track record of success. The logic behind these investments is: A firm will invest in 100 startups, the majority will fail, some will survive as modest but successful businesses, and one will become the next giant.
To sufficiently pool risk and foot the large bills associated with startup ideas, venture capitalist firms generally also require investors to be accredited investors. Since the model is to spread funds across a number of firms, before working with a venture capitalist firm, make sure your values match the firm’s so your capital is going towards businesses you want to support.
For those excited about venture capitalism, there are some crowdfunding platforms for startups that do not require accreditation, but investing in those involves a high level of risk for low net worth investors. If you want to get into venture capitalism before you reach a high enough net worth or income level, choose the next approach instead, so you do not have a significant portion of your capital in risky investments.
Invest Your Skills in the Next Big Idea
If you are not an accredited investor, you can still invest in a startup that inspires you by committing your skills and knowledge instead of capital. If you have the right network and skill set, these opportunities will present themselves over time. Startups may reach out to you for assistance with a project. You can offer your time and expertise in exchange for equity in the venture, rather than initially seeking payment for your work, if you believe in the business and want to bet on its future.
If the business becomes successful, you not only receive returns beyond what you would have been paid for your time and expertise, you also get to add that success to your resume and raise your rates for the next customer seeking your skill set. A win-win with no money invested!
Become an Angel Investor
Angel investing is when high net worth individuals invest a large amount of capital in a specific business venture, effectively breathing life into it with their money, in exchange for large profits. Angel investors typically receive 20–25% of profits in return for their large and risky investments!
This is the kind of investment that investors should only make when their net worth is high enough that they are truly exploring how to throw large amounts of capital towards a certain cause close to their heart or a specific business venture that inspires them. If you have more money than you know what to do with, make the world a better place by becoming an angel investor.
There are various paths to investing in small businesses, each with their own opportunities and risks. Carefully analyze your options and choose the one that is right for you!
About the Financial Accounts Series: The Financial Accounts Series is a four-part series discussing financial accounts that can improve the health of your finances. The Phippen Tax & Financial Services team will provide a deep dive on each of the accounts listed in Part 4, Accounts to Have for Fun, before releasing the bonus edition, Accounts Your Kids Need. If you missed Part 1, Accounts You Need First, Part 2, Accounts You Need Next, or Part 3, Accounts You Want, start there! If you would like to seek additional guidance about your personal finances or the specific organization and composition of your financial accounts, please contact Patrick Phippen or complete a new client form if you have not worked with Patrick in the past.
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