Small businesses are in many ways the engine of the economy. It’s also a great time to be starting or running a small business. All of the economic indicators are pointing to a climate that’s supportive of new small businesses. What does that mean for investors? Is it a good time to be putting money into small businesses as an investment?
Small businesses can be a great choice for an experienced investor. When the stock market is performing well, investors can typically see returns of about seven to eight percent. The potential gains as an investor in a small business can be much greater. The risk of failure, however, is also greater. For example, over half of all restaurants fail during their first year in business. Overall, a third of small businesses don’t make it past the two year mark. Half don’t make it to five years. Even when a small business becomes successful, there is typically no return for investors until about the three-year mark.
Investing in a small business is not the same as buying stock or putting money into a 401k. It’s much more personal and it can carry more risk. Investing in this way is something that should only be done by people who are experienced when it comes to finance. It’s also not something that people should take lightly. Investors should only be putting money into these ventures if they can afford to lose it. Although an investor should be excited about the project they’re putting money into, it’s important not to lose sight of indicators for future success.
It’s not a good idea to invest in a local business just because it seems quirky or fun. Investing because the entrepreneur is a friend can also be a dicey proposition. Ask to see documents like profit and loss statements for the business. Look at the overhead costs associated to the business, too. Also, if possible, it’s a good idea for investors to try and get a controllable interest in a small business. Having a 51% share in a business means that the investor can step in and take over should things start to go awry. This can be the difference between seeing a 100% loss as opposed to a turnaround.