When you think of a typical retail investor’s portfolio, it usually consists of Stocks, Bonds, Mutual Funds(including ETFs), and even Real Estate. However, your portfolio doesn’t have to be limited to these assets; most of the worlds wealthy either started a business or bought into one as a vehicle to make a bang for their buck. Having a percentage of your portfolio set for small business (or businesses) investing is worth including in your portfolio.
How Can I Begin Small Business Investing?
The two types of small business investments are equity investing and debt investing. When you invest in an equity buisness, you’re providing capital in exchange for a percentage of ownership. This entitles you to all the profits and [unfortunately] the losses. By investing in debt business, you’re loaning the business capital in exchange for a guarantee the business will pay you back the loan in its entirety plus interest. If the business goes under, you (the creditor) are entitled to a percentage of the business’ assets to get your money back as with all things investing: diversify your portfolio by investing in both equity and debt.
Why Should I Invest In A Small Business?
I’m assuming you want to make money…big money, investing In Small Businesses invites you with a potential for unlimited gain. Some of the benefits of investing in a small Business include:
Tax Advantages: The Tax Cuts and Jobs Act (2017) allows for a new 20% deduction on pass-through income for any Qualified Small Business (QSB). Businesses organized as S-corporations, LLCs, Partnerships, and Sole Proprietorships can qualify for this deduction. The Tax Cuts and Jobs Act also lowered the marginal tax rate for small businesses–allowing for businesses to expand and grow (which benefits you the investor).
Cash Flow and Realized Gain: By investing in a small business, you benefit from the cash flow the business makes. Based on how profitable the small business is, many small businesses have the potential to grow faster in value than many stocks–giving you a bang for your buck.
‘High Risk equals High Reward’ is the name of the game.
Having an investment in a small business has many rewards but it also comes with many risks. Some risks associated with Small Business investing include:
Financial Risk: About 20% of small businesses go under in a year and almost 70% of small businesses go under in 10 years. It is important to note that if you invest in a small business organized as a Limited Liability Company(LLC), S-Corporation, or a Limited Liability Partnership (LLP); if unfortunately, your small business does go under, then your personal assets are shielded from any creditor claims or litigation. In a small business organized as a sole proprietorship or a general partnership, then your personal assets could potentially be seized to pay off any debt or other compensation.
Principal-Agent Conflict: Oftentimes, workplace politics can be a big hurdle to realize your business’ gain. You will not necessarily be the manager or the employee at your business. This leads to a principal-agent conflict wherein you, your managers, and employees can’t find common ground on how to keep the business growing. If you own a minority percentage in the business, you’ll probably not have your way, but if you own 51% or more (majority shareholder) of the business, the managers and employees will have to toe your line.
Small Businesses are the backbone of the economy, and by having an investment in a Small Business (or businesses), you invite yourself to a plethora of benefits. The potential for unlimited gain comes with the potential for unlimited risk; however, with proper portfolio and business management, many of these risks can be mitigated. This is by no means an exhaustive guide and as always, do your proper research to stay up to date with current market conditions and tax regulations.
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