I strongly recommend approaching all kinds of investors, including those who may have never invested before and don’t think of themselves as investors. These people can be amazing supporters and allies. The challenge is that sometimes some education is needed to help these folks even consider an investment in a small business. They have been told for so long that “investing” is something done by VCs and hedge fund managers, not regular folks like them. Here are some questions they might ask and how you can respond.
Is this crowdfunding?
It depends on what you mean by crowdfunding. One very common type of crowdfunding is where you post some kind of a project on a crowdfunding site like Kickstarter and solicit donations. Donors are often promised something in return for their donation like a t-shirt or a thank you note.
That is not what I’m doing. I’m actually raising investment capital. This means that if you decide to invest and things go as planned, you will receive a financial return on your investment – just like you do when you put your money in the bank or invest in the stock market.
How is that legal? I thought it was illegal for small businesses to ask for investment from regular people.
Some lawyers and financial advisors might tell you that but it’s actually not the case. My offering is being done in compliance with both state and federal securities law.
I’m not an investor.
Actually, if you’re like a majority of the US population, you are an investor! You may not think of yourself as an investor, but if you have retirement accounts, bank accounts, mutual funds, etc., you are an investor! And you have options about where you can put your investment dollars.
Are you paying a market rate return?
The term “market rate” is very subjective and hard to define. What I’m offering is an X% annual payment in the form of [interest/profit distribution]. This return is much better than what you would get if you put your money into a certificate of deposit at a bank, where you can get currently get X% interest. Of course, there is more risk if you invest in my business because your investment is not insured by the FDIC like a bank deposit is. The return I am paying to my investors is based on my projections about the future of my business. I want to pay enough to fairly compensate my investors while also making sure that I don’t promise more than I can realistically afford to pay and still keep my business healthy.
Remember that all investment is risky! Even an investment in an indexed stock mutual fund can be quite volatile and is affected by factors that are completely out of the investors’ control.
Also, there is a lot of hype about what a market rate return is. For example, you may hear some investment advisors say you can expect a 6-8% return if you keep your money in the stock market over the long term. The reality is that the Dow Jones Industrial Average annual return for the last ten years is a less than 3.25% and past returns cannot be used to predict the future. Some experts are saying that the world’s financial markets are likely overvalued by at least $20 trillion due to stranded fossil fuel assets and a recent analysis cited in the Wall Street Journal predicts a 17% stock market drop caused by a pulling back from liberalized global trade.
How will I get my money back?
You may have heard of the Silicon Valley model of investment where the investor gets paid back when the company is sold or goes public. There are some stories of investors making millions when they got lucky and invested early in a company that ended up going big. In reality, the majority of investments that depend on a big sale or IPO don’t succeed and the investors end up losing money.
CHOOSE FROM ONE OF THE TWO OPTIONS BELOW DEPENDING ON WHICH ONE IS TRUE FOR YOU:
That model doesn’t fit my business – I expect to grow modestly every year and I have no immediate plans to sell to a larger business or do an IPO. That’s why I am compensating my investors by sharing my profits. My plan is that by the Xth year, I will be able to pay back my investors their original investment, in additional to the annual share of profits.
I do expect to sell my business someday, but I will not sell at any cost. I will only sell to a buyer that I believe will stay true to the mission of the business and I want the freedom to choose whether or not to sell based on what I believe to be in the best interests of the business and its long-term impact. However, in the meantime, I plan to compensate my investors by sharing my profits.
So are you saying this is a “lifestyle business?”
I have heard some people categorize businesses that do not follow the Silicon Valley model as “lifestyle businesses.” This seems to mean a business that grows modestly and is not shooting for a unicorn exit. In that sense, I guess you could say that my business is a lifestyle business. I have noticed that some people think that these kinds of business are not “investable.” Nothing could be further from the truth! Investing in a business that shares a reasonable return from its profits every year can be a great investment, compared to an investment that gambles on that one in a million chance of a unicorn exit!
Isn’t this a risky investment?
Of course, all investment is risky to some extent and not all small businesses succeed. You should only invest what you can afford to lose.
But here are some things to keep in mind when evaluating risk:
- Look at your whole portfolio and remember that diversification mitigates risk. If almost all of your investments are in the stock market, investing in a small business whose success is not tied directly to the ups and downs of the public markets can be a good way to diversify your portfolio. Think about it – almost all of most Americans’ investments are in giant multinational public companies. But 99% of US businesses are small private companies that account for half of all employment and half of all production. Why put all of your investment dollars in only half of the economy?
- The stock market has been likened to a casino – it has become so opaque, trading is increasingly conducted by algorithms, and financial instruments have become so far removed from the real economy that it is hard to trust that it will continue to be a safe place to put your nest egg.
- Warren Buffett’s advice? “Never invest in a business you cannot understand.” Most investors not only don’t understand the businesses they’re investing in, they don’t even know what businesses they’re invested in! They just let they’re fund managers make all the decisions and hope for the best. Why not invest in some of the businesses that you know and understand?
- Most of our investments are made through intermediaries (often more than one) like stock brokers, fund managers, and investment advisers. When you invest directly in a business, you eliminate the fees and percentages taken by these intermediaries and there is more transparency about what you are actually investing in.
- A business is all about the people who run it. When you invest in a small business, you’re investing in the founder based on your opinion of his or her commitment, integrity, and abilities. A small business owner is generally going to be much more committed to her business’ success than a CEO of a multinational public company. CEOs move around from company to company and get their golden parachutes when they leave. Entrepreneurs usually start their businesses to express their most dearly held dreams and passions. Their business is their baby so they will stick with it through thick and thin.
- When you invest in a business based on your relationship with the owner, that owner is going to feel personally responsible for your investment dollars. The last thing she wants is for someone she knows to lose money by investing in her business. She will do almost anything to avoid having to tell her investors that she has lost their money or is unable to pay them as much as she had promised. When you invest in a faceless multinational corporation, there is no similar feeling of personal responsibility to the investors.
Besides the financial returns, what are the other benefits of investing in your business?
When you invest in a small business, you often get benefits that go beyond purely financial returns.
These vary depending on the particular investment and business but they often include
- Having the pride of knowing that you helped a business that’s important to your community
- Being able to tell your friends and colleagues that you invested in a business they may know and love
- Being part of a community of investors with similar values
- Having the opportunity to learn from the business owner about the details of the business
- Providing support to the business owner when she needs it – advice, contacts, business referrals, etc.
- Having some ability to affect the success of the business as a customer and a source of referrals
- Being invited to special events
- Being recognized publicly as a supporter of the business
- Discounts and perks
- Knowing that your investment dollars are supporting something that is having a positive impact in the world
Remember, all investments have an impact – what impact do you want your investments to have? When you invest in a mutual fund of public company stocks, does that create any positive impacts in your community or on things that are important to you?
Investing in small businesses allows you to invest in the real economy in a business that employs people and provides useful goods and services. When you invest in public company stocks, your money doesn’t even go to that company – it just goes to the previous owner of the stock!
Why not use some of your investment dollars to invest in things that are important to you? Community gathering places, alternative energy, businesses that create good local jobs, etc. Imagine if everyone moved just a small percentage of their investment dollars to small businesses creating a positive impact in the world – we could create a better world by simply being more mindful about where we put our money.