A Basic Guide to Investing in Small Businesses (2024)

FAQs

How does investing in small businesses work? ›

Equity investment: With an equity investment, you buy a portion of the business. You become a partial owner. In some cases, you have a voice in how it is run and its future direction. If the business performs well, you can make money by receiving a share of its profits or by selling your stake at a higher price.

Step 1: Perform market research around your idea

It also provides demographic information on your target customers, such as their income and where they live. You generally have two options when it comes to research – review existing sources or conduct your own analysis.

The cheapest businesses to start may cost as little as $12,000 initially, but other businesses like restaurants can run from $400,000 or more. The best way to determine your startup costs is to list all expected expenses and the dollar amount for each item.

Just like the public markets, startup investors make money by selling their shares in a company at a higher share price than they paid for them. Unlike the public markets, there aren't as many opportunities to frequently trade shares in private companies and startups.

It is typically based on one of the following broad models: Buy a product, distribute it for a higher price than you bought it for (example: luggage) Manufacture a product, sell it for more than it cost to produce it (example: picture frames)

A sole proprietorship is the easiest and simplest form of business ownership. It is owned by one person. There is no distinction between the person and the business. The owner shares in the business's profits and losses.

Typically, a business should have a cash buffer of three to six months' worth of operating expenses — the regular day-to-day costs of running a business. However, this amount depends on many factors: the industry, what stage the company is in, its goals, and access to funding.

How much money should I keep in my small business account? ›

Ideally, your business should save at least 10% of your monthly profits or three to six months of expenses to keep you in good financial standing. Generally speaking, you should aim to have enough cash or liquid assets on hand to cover several months' worth of expenses in the event of an emergency.

To get paid, LLC members take a draw from their capital account. Payment is usually made by a business check. They can also receive non-salary payments or “guaranteed payments” — basically a payment that is made regardless of whether the LLC has generated any net income that month or quarter.

If the startup takes off, you'll both reap the financial rewards. If your company falls flat, on the other hand, an angel investor won't expect you to pay back the offered funds. Though you aren't officially obligated to pay back your investor the capital they offer, there is a catch.

Most investors understand the rules of the game, which is that once they've invested in a company, that money belongs to the company, and they can't ask for their money back.

The most common way to repay investors is through dividends. Dividends are payments made to shareholders out of a company's profits. They can be paid out in cash or in shares of stock, and they're typically paid out on a quarterly basis. Another way to repay investors is through share repurchases.

The primary benefit of investing in small businesses is getting in on the ground floor of a potentially lucrative investment opportunity. The biggest risk is losing money on your investment because either the business failed or didn't meet financial expectations.

Dividends are a form of cash compensation for equity investors. They represent the portion of the company's earnings that are passed on to the shareholders, usually on either a monthly or quarterly basis. Dividend income is similar to interest income in that it is usually paid at a stated rate for a set length of time.

Qualified small business stock is stock meeting certain qualifications that allow U.S. investors to exclude or defer federal capital gains taxes upon sale of the stock. To enjoy such tax benefits, both the investor and the issuing company must meet a series of criteria.