Investing in small and/or local businesses

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
ssn
Posts: 14
Joined: Sat Jan 25, 2020 10:15 pm

Investing in small and/or local businesses

Post by ssn »

Hi,

Does anyone know if an individual can invest in small and/or local businesses? What is the mechanics? Do you have first hand experience? What are some of the gotchas? Are there any reputable forums providing information about such businesses?

Thanks,
-ssn
User avatar
arcticpineapplecorp.
Posts: 7117
Joined: Tue Mar 06, 2012 9:22 pm

Re: Investing in small and/or local businesses

Post by arcticpineapplecorp. »

ssn wrote: Mon Sep 07, 2020 11:40 am Hi,

Does anyone know if an individual can invest in small and/or local businesses? What is the mechanics? Do you have first hand experience? What are some of the gotchas? Are there any reputable forums providing information about such businesses?

Thanks,
-ssn
I would strongly dissuade you from doing this. I understand it may feel good to support local businesses but that doesn't make them good investments.

Also, you won't be properly diversified by owning local and or small businesses. You would have geographical risk (concentrating your money in one location) and size risk (not to mention sector risk and possibly style and manager risk as well). If you own the market you have companies that are small, large and mid (not micro as you're suggesting), value and growth, geographically and industry/sector diversified and you don't have to choose in which to invest and which to avoid.

The small businesses you're likely after aren't publicly traded so there's no way to know how their books are run. There's too many unknowns that you really can't make an informed decision, so it's more akin to gambling. It's also far riskier because a smaller business (non publicly traded company) doesn't have to file with the SEC so it could be too late once it's found out the company is on shaky ground and you will have lost your investment without any forewarning.

How would you value such a company if you can't look at (or trust) it's books because it's not audited? Why would you take such risk? Are the returns of such ventures so much greater than owning the market? If so, isn't that because of the added risk?

Most small companies can expand by taking loans rather than getting outside investors and diluting the owners shares. If the company can't get a loan to expand their business and therefore are going to outside investors doesn't that tell you something about the ability of a small company that can't get a loan to expand? Have they really been doing well then?

you can say, well maybe they need more money than they can get from a bank. fine. if that's true, how and when are they planning on expanding? how much do you know (and approve) of their plans? Do you want to be following several companies and have to follow their plans for expansion? Do you want to (are you able to?) review their books regularly to see how your investment's doing? Can you go years before there's any payoff? Can you get your money back whenever you need/want or is it locked up in the company's continued operations?

Is that how you want to spend your free time and money?

if you like a small business the best thing you can do to support them is continue to patronize their business.
It's "Stay" the course, not Stray the Course. Buy and Hold works. You should really try it sometime. Get a plan: www.bogleheads.org/wiki/Investment_policy_statement
smitcat
Posts: 7020
Joined: Mon Nov 07, 2016 10:51 am

Re: Investing in small and/or local businesses

Post by smitcat »

ssn wrote: Mon Sep 07, 2020 11:40 am Hi,

Does anyone know if an individual can invest in small and/or local businesses? What is the mechanics? Do you have first hand experience? What are some of the gotchas? Are there any reputable forums providing information about such businesses?

Thanks,
-ssn
Local angel investing groups - perhaps check with your local Small Business development center and/or SCORE in your area.
Topic Author
ssn
Posts: 14
Joined: Sat Jan 25, 2020 10:15 pm

Re: Investing in small and/or local businesses

Post by ssn »

Thank you very much arcticpineapplecorp for your quick response. The points which you have raised are all valid!

I do invest in 60/40 portfolio but I feel that if the stock market is not doing good when I need the money then that will be a problem.

Another alternative is investment in real estate but it too has its pros and cons. What do you think about it?

-ssn
ScaledWheel
Posts: 147
Joined: Sat Jul 23, 2011 8:06 pm

Re: Investing in small and/or local businesses

Post by ScaledWheel »

Commenting in order to follow this topic. I was actually considering posting something similar a few days ago.

I think a lot of this depends on how much you have to invest and the why you want to invest in these smaller businesses. I initially got interested in this via an episode of Invest Like the Best (http://investorfieldguide.com/beshore/), but this is from the eyes of an asset manager/full time investor.

Personally, for myself, the why would be to:
1. create streams of income separate from my primary job that allow me more autonomy/flexibility than being an employee
2. learn about verticals in a business area I am interested in learning more about
3. improve these businesses using my "rare and valuable" skills

From a Boglehead perspective, objective 1 would be much easier served with a bond fund, so the question comes down to whether or not objectives 2 and 3 are worth the time investment/risk compared to the simple route of following the Boglehead way.

As for the how much to invest, well this is an ongoing conversation with the spouse :D We already own rental real estate and the target is to have 20% of our portfolio invested in real estate/alternatives.

What types of "small businesses" are you thinking of, and do you know if they even need investment? You're going to have different opportunities coming to the table with $10,000 vs. 100,000. I have found business groups for the types of businesses I am interested in. Signing up for those allows me to get better information on the industry and also allows me to become part of the community so that if/when an opportunity comes up, I won't be some faceless outsider with a check. Per the podcast, some of these opportunities come from people who have built a business over decades and are looking to turn some of that business value into cash.

I am also thinking of this as a 5/10 year plan. We're in our early 30's so not in any type of hurry.
Topic Author
ssn
Posts: 14
Joined: Sat Jan 25, 2020 10:15 pm

Re: Investing in small and/or local businesses

Post by ssn »

Thank you ScaledWheel. I have several questions for you because I and my wife have very similar thoughts as yours.

We have barely started the thought process so I cannot tell what kind of businesses we are interested in - but I think we need to understand at least good part of it to make informed decisions.

Taking cue from smitcat, I was looking at local angel investing group. I will probably enroll myself in it so that as you said, I will not be unknown to the community.

On the subject of rental property, we will be having 2nd mortgage. If we go with condominium then there will be HOA as well. Finding a good renter is also a non-trivial task. However, the properties in reasonably good town appreciate over the years. So we are in a fix whether to invest in rental property or to invest in small businesses.

What were your deciding factors for the rental property? Have you outsourced finding renter or do you do it on your own? What about maintenance?

Thanks,
-ssn
ScaledWheel
Posts: 147
Joined: Sat Jul 23, 2011 8:06 pm

Re: Investing in small and/or local businesses

Post by ScaledWheel »

ssn wrote: Mon Sep 07, 2020 1:34 pm Taking cue from smitcat, I was looking at local angel investing group. I will probably enroll myself in it so that as you said, I will not be unknown to the community.

On the subject of rental property, we will be having 2nd mortgage. If we go with condominium then there will be HOA as well. Finding a good renter is also a non-trivial task. However, the properties in reasonably good town appreciate over the years. So we are in a fix whether to invest in rental property or to invest in small businesses.

What were your deciding factors for the rental property? Have you outsourced finding renter or do you do it on your own? What about maintenance?
Getting involved in angel investing is a little different than what I am planning on, as I see angel investing as hoping to hit a home run whereas I'm more looking to become an owner in something that generates income. I have no experience in angel investing but if you want to go that route think of where your experience can lend itself to evaluating the viability of a business or what mentorship you could provide to founders.

As far as rental properties, it's worked out quite well so far but even now compared to two years ago (when we purchased) it seems like the market is absolutely flooded. Commercial RE could be interesting at the moment, but I haven't looked into it. I personally like the idea of helping to build out a product rather than seeking rents. But I also haven't looked much into the tax implications of RE vs. a business. I know that RE gets favorable tax treatment, which needs to be a factor when weighing the two.

We bought the rental property as our first mortgage, so probably can't compare to your situation. The property we own is a duplex, and I don't think we'd buy a property that is not at least 2+ units. We're in the enviable position where we don't rely on the rental income for anything, so we're perhaps a little too generous to our renters, but that also means we haven't had any turnover yet. We have hired a property manager, but that is because we moved away for work. If we were local we would still be managing it. Looking at RE in the same area, prices have gone up so much in the last two years I would hold off on buying something else.
User avatar
arcticpineapplecorp.
Posts: 7117
Joined: Tue Mar 06, 2012 9:22 pm

Re: Investing in small and/or local businesses

Post by arcticpineapplecorp. »

ssn wrote: Mon Sep 07, 2020 12:07 pm Thank you very much arcticpineapplecorp for your quick response. The points which you have raised are all valid!

I do invest in 60/40 portfolio but I feel that if the stock market is not doing good when I need the money then that will be a problem.

Another alternative is investment in real estate but it too has its pros and cons. What do you think about it?

-ssn
when you need the money? isn't that what the bonds are for?

stocks are for making you money.
bonds are for keeping the money you've made safe(r).
cash is for spending.

re: real estate, are you interested in having a second/side job? That's what being a landlord entails. Might not be a lot of work (depends) but you will have to make or schedule repairs, advertise and show properties and check credit, evict (possibly) and so on. It's not no work or passive investing which is the beauty of your 60/40 portfolio. totally passive. why divert from that? Why not just add to that if you have additional money you don't seem to know what to do with? Would you rather have a certain amount in 60/40 or a LARGER amount in 60/40? Even if you say, "I'll outsource and higher a property manager to do all the work" they're not running a charity. It's going to cost you (some profits). Wouldn't you just do better getting all the profit (of the stock market) rather than give away profit to a property manager?

Why all of a sudden say, "Instead of having a LARGER amount in 60/40, I'm gonna now do something completely different like real estate and/or angel investing"??? Not sure I'm following the logic there.
It's "Stay" the course, not Stray the Course. Buy and Hold works. You should really try it sometime. Get a plan: www.bogleheads.org/wiki/Investment_policy_statement
humblecoder
Posts: 288
Joined: Thu Aug 06, 2020 8:46 am

Re: Investing in small and/or local businesses

Post by humblecoder »

ssn wrote: Mon Sep 07, 2020 12:07 pm Thank you very much arcticpineapplecorp for your quick response. The points which you have raised are all valid!

I do invest in 60/40 portfolio but I feel that if the stock market is not doing good when I need the money then that will be a problem.

Another alternative is investment in real estate but it too has its pros and cons. What do you think about it?

-ssn
What is your goal with this endeavor? If it is because you might need money if the stock market is not doing well, then this is the exact opposite of what I would do. First, if the stock market is down, then there is a very good chance that small businesses are going to be down as well. At least with the overall stock market, it might tank 50% in a down market, whereas a small business could go out of business completely, meaning you are down 100%. Second, an investment in a small business is not liquid, so getting your money out when you need it is going to come with a transaction cost. If you need to cash out, you will need to find a willing buyer who is willing to pay.

If your goal really isn't asset protection but making money, again there are better ways to do it. Do you know what the failure rate for small businesses is? There is a good chance you aren't going to see any money from your investment. You either need to find the right business (and any business that has a shot is going to require that you pay a premium to get in on the action) and/or you need to be actively involved in the day-to-day working of the business, which is an investment of your time.

And even if you do that, you still need to be lucky. Who would have predicted COVID would hit and wipe out hundreds of otherwise successful small businesses? And if it isn't COVID, it the big box store that moves in next door that undercuts your prices. Or the newly introduced law or regulation which increases your costs. Or hundreds of other things that don't break your way.

If it were me, if I were going to invest in a small business, it would need to meet the following minimum requirements:
- I am the controlling owner
- I have some competitive advantage that somebody else couldn't replicate, so I at least have some shot at success
- Small capital outlay with a minimum of fixed expenses
- I am willing to make it my full time job

The only way I would consider doing it as a passive investment is if I had the financial ability to invest in hundreds of small businesses to diversify myself. That way, that one winner that I pick will outweigh the hundreds of inevitable losers. Or I would just invest in a VC fund and let the VC do the work for me!
Topic Author
ssn
Posts: 14
Joined: Sat Jan 25, 2020 10:15 pm

Re: Investing in small and/or local businesses

Post by ssn »

Thank you humblecoder and arcticpineapplecorp for your detailed replies. These are points worth thinking. And sorry for the delay in response, life caught up!!
-ssn
Post Reply