A report issued in 2019 by the Small Business Administration (SBA) showed that small businesses account for 44% of U.S. economic activity.
These businesses provide jobs and bring along more careers and opportunities. Cyclically, successful small businesses put money back into their local community, supporting the creation of more small businesses and public services. For investors, investing in small businesses can grow their portfolios and generate long-term returns with a good record of social impact. These are the two main ways to begin investing in small businesses:
Equity Investments
An equity investment is an ownership stake in a company. Investors provide capital in exchange for a percentage of the profits—or losses. For small businesses, typical investments range from $100,000-$5 million, and these investments can help aid capital expenditures needed for expansion, running daily operations, hiring new employees, and reducing debt. Although equity investments contain the most risk, they can also result in the largest financial gains.
An example of equity financing is the Small Business Administration’s license and regulation of a program called Small Business Investment Companies (SBIC) which provides venture capital funding to small businesses. Venture capital (VC) firms pool professional investors’ money to invest in small and possibly high-risk startups. This equity investment may grant such firms a seat on the business’s Board of Directors, allowing them more “control” over their investment and additional resources for the business.
Debt Investments
A debt investment is a loan of money in exchange for the promise of interest income. Debt capital is usually provided in the form of direct loans with regular amortization or the purchase of bonds issued by the business that provides interest payments to the bondholder. A typical loan ranges from $150,000 to $10 million, with an interest rate between 9% and 16%. One of the biggest advantages of debt investing is that it has priority over equity investors. This privileged place in the capitalization structure allows debt investors the possibility that they can escape unscathed if a company fails, while equity investors take the loss.
The SBA also plays a role in helping small businesses gain contracting opportunities and access to funding with various loan programs that increase the chances small businesses will qualify for loans. Its three main loan programs—7(a), Microloan, and CDC/5O4—help small businesses obtain financing and build business credit. Investors, banks, and credit unions can also use these programs to improve both their credit and Community Reinvestment Act (CRA) ratings.
At Equalize Capital, we specialize in SBA bank loans for growing businesses and companies that struggle to obtain traditional bank financing. “Our fund acts like a buffer to make it easier in accessing this type of opportunity,” says CEO Lee Calfo in an interview with Laura DeGraff, CMO, and Carissa Bobenchik on the topic of Equalize’s community development and home mortgage funds. These funds play a vital role in onboarding investors to small business investing by allowing them to make passive investments that benefit all stakeholders at play.
Take the next step:
Here’s Lee’s advice for banks and investors wanting to engage in small business investing: “If I were a bank and needed services similar to those Equalize provides, these are the phrases I’d first search for online: low-income mortgages, community reinvestment act (CRA) investments, community development lending, and minority residential home loans.” Researching small business investment programs and qualifications on an individual basis will help narrow down the right investing path. The majority of investors are unaware that community development or small business funds even exist and miss out on this socially and financially rewarding investment opportunity.
