State laws have been relaxed to make it easier for small business to raise start-up and growth financing from the public. Many investors view this as an opportunity to get in on the ground floor of an emerging business and to hit it big as the small businesses grow into large ones.
Statistically, most small businesses fail within the first few years. Small business investments are among the most risky that investors can make. This guide suggests factors to consider for determining whether you should make a small business investment.
Risks and investment strategy
A basic principle of investing in a small business is: Never make small business investments that you cannot afford to lose! Never use funds that may be needed for other purposes, such as college education, retirement, loan repayment, or medical expenses.
Instead, use funds that would otherwise be used for a consumer purchase, such as a vacation or a down payment on a boat or a new car.
Above all, never let a commissioned securities salesperson or office or directors of a company convince you that the investment is not risky. Small business investments are generally hard to convert to cash (illiquid), even though the securities may technically be freely transferable. Thus, you will usually be unable to sell your securities if the company takes a turn for the worse.
In addition, just because the state has registered the offering does not mean that the particular investment will be successful. The state does not evaluate or endorse any investments. If anyone suggests otherwise, they are breaking the law. If you plan to invest a large amount of money in a small business, you should consider investing smaller amounts in several small businesses. A few highly successful investments can offset the unsuccessful ones. However, even when using this strategy, only invest money you can afford to lose.