It’s always been said that small businesses are the heart of the American economy. Statistically they make up more than 43 percent of the economy. They provide more than 1.5 million jobs every year with 64 percent of new jobs created every year. Furthermore, small businesses contribute roughly 43.5 percent of this year’s annual GDP compared to 48 percent the year in 2019. Small businesses have taken a serious hit since the start of the pandemic, they have had to become innovative to adapt to the changing times but for those who could not keep up it was deadly.
Investing in small business has a lot of benefit besides the obvious one of supporting local businesses and entrepreneurs. Some of those advantages are for one the potential to grow faster than larger corporations due to their ability to easily diversify. They also have possibility of having greater exposure to their domestic economies ultimately protecting them against a volatile global economy and finally, the added benefit of bigger companies potentially paying higher premiums to shareholders in the case of a merger to take control of the company.
Just like any investments, small business investments also have a few downsides, the main one being the risk incurred by investing in a smaller company rather than a bigger one. Besides the obvious risk investors take on, there is also the added question of liquidity. Small business investors have to consider their exit strategy and their ability to liquidate their shares considering that there might be a smaller pool of investors who might be willing to buy their shares.
Investing in small businesses, is just as lucrative as investing in the stock market but it also carries the same amount risk depending on which investment an individual is looking for. And just like there are different types of investors, there are also different types of investments. There are mainly 3 types of small business investments: equity investments, lending investments and cash equivalents. They are all really great options, and they apply to each individual based on their needs.
Equity investments are investments that allow the investor to become a partial owner of the business. They are also called ownership investments. This type of investment is just as profitable as they are risky. As a partial owner, the investor will take on the profits as much as they will the loss, but they will have a say in the management of the business.
Lending investments are self-explanatory. Just as the name suggests, the investor, acting as a bank, lends money to a small business with the intention of getting their money back with interest. This type of investment is less risky than an equity investment, but they are also less profitable. This type of investment is the most common and gives the investor a higher claim of repayment over the shareholders in the case the business fails.
Finally, there are cash equivalents, which are securities issued by the business. They are the safest type of investment and have the ability to help determine the health of a business to see if they are worth investing in or not. They, however, have very low returns compared to the other options. Some examples of cash equivalents are commercial paper issued by large corporation for short term obligations and treasury bills which are short term bonds or securities issued by the government.
Given the uncertainty carried by the previous year and this troublesome times, one might wish to shield themselves against the growing economic volatility and political turmoil brought on by the pandemic by investing in local business and helping their community grow while adding an additional source of passive income to their portfolio.
How to Invest in a Small Business. (2020, April 22). Retrieved from Saving Freak: https://www.savingfreak.com/investing-in-small-business/
The pros & cons of investing in smaller companies. (2018, September 1). Retrieved from Barclays: https://www.barclays.co.uk/smart-investor/news-and-research/investing-insights/the-pros-and-cons-of-investing-in-smaller-companies/#ref3