5 Rules for Small Business Investment

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5 Rules for Small Business Investment

Whether you’re going the startup route or investing in someone else’s company, small to medium business investing is a smart way to gain some financial independence. However, it’s not without its risk. Before you put your money and time into a company, make sure that you follow a few simple rules for smart business investing. Equity investing is a direct investment in a company, usually in the form of cash in exchange for a percentage of the profits. Beware that you’ll also take on a share of the losses if the business doesn’t do well. Your return is variable; therefore, you have a stake in seeing that the company succeeds.

If you’re considering making a debt investment, you’re also putting cash into a company. However, this is usually in the form of a direct loan at agreed upon terms and interest. This provides you with a set ROI whether the business succeeds or not. An equity investment offers the highest return, but your losses could be greater. There’s also a debt/equity hybrid model that’s similar to a preferred stock investment model. However, this offers less than ideal returns many times. Regardless of which type of investment you’re looking into, following these rules will help reduce your risk.

Do Your Research

Be wary of anyone who comes to you wanting a loan for their venture. Is it a new company, a franchising opportunity, or an established business going through a period of growth? Find out if the person has a solid business plan, how much they know about the industry, and what it takes to run a business. Learn as much as you can about that type of business model and prospects in that particular location.

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Never Invest Money You Can’t Afford to Lose

This is probably the most important aspect of financial management. Some people have a high tolerance for risk, but there’s no sense in wagering your retirement, the kids’ college funds, or you home. Make sure the corporate structure id favorable to you should anything happen. For example, a limited liability corporation (LLC) protects your personal assets in case of a financial loss or litigation.

Get Everything in Writing

It would be nice if business agreements relied on a handshake and a promise, but that’s not how it is any more. Make sure that all terms are spelled out explicitly and in writing. Consult with a lawyer before signing any contracts.

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What Are the Tax Consequences?

Is this investment going to put you in a different tax bracket? Are there tax credits or rebates available due to the type of investment or industry? An accountant can tell you more about any possible liabilities or benefits.

Invest in What You Know

It’s tempting to get in on the “Next Big Thing.” But, if you know that particular industry, it’s easier to guide the performance of the business and anticipate returns. For example, if you have a background in landscaping or tree care, putting your money into a Houston lawn care service allows you to offer your experience and guidance in addition to bringing in a cash infusion.