Now Is The Time To Invest In Small Businesses

Small businesses are sometimes overlooked by investors, but if you are trying to diversify your portfolio, you may want to consider adding some small business investments. There are a range of options you can explore, from opening a business as an owner operator to directly investing in someone else's small business, or purchasing shares in a small business. Wondering if you should jump in? Here's a look at some of the benefits of investing in small business followed by some of the different ways you can get your money engaged in this sector of the economy.

Reasons to Invest in Small Businesses

1. Significant Part of the Economy

In spite of all the chatter about big corporations, small businesses still make up a huge part of the economy. There are over 28 million small businesses in the country, and they account for more than half (54 percent) of all retail sales. Even their footprint is large — small businesses take up about one-third to one-half of all retail space. By tapping into this investment sector, you get involved with one of the biggest sectors of the American economy.

2. Job Creation

Small businesses also provide the majority of jobs in the country. When you invest in these companies, you become a job creator, indirectly. Although big companies, like Walmart, are the largest single employers in the country, small businesses still provide more jobs overall. In fact, 55 percent of jobs are with small businesses.

Since the 1970s, nearly two-thirds of jobs that have been created have come from small businesses. To put that into perspective, since 1990, big businesses have cut 4 million jobs from the economy, but small businesses have added twice that number.

3. The American Dream

When you invest in large corporations or investment funds, not only do you earn money or interest for yourself, but you also help line the pockets of a giant corporation and its members of the board. When you put your money into a small business, you help a family or a small group of people achieve the American dream. On an emotional level, that can feel like a positive investment strategy.

4. Tax Cuts

As of tax year 2016, the government also offers tax cuts for investing in small businesses. These tax cuts were part of the economic recovery plan of 2009, but they continue to reward investments in small business today.

To enjoy a tax break, you need to invest in qualified small business stock (QSBS). The Internal Revenue Service defines QSBS as original issue stocks from domestic C corporations. You cannot qualify for this tax break with investments into LLCs or S corporations. In addition, the company must have less than $50 million in assets and may need to meet other criteria.

Normally when you earn money selling stocks, you have to report a capital gain and pay tax accordingly. With QSBS, you may be able to exclude most of your gain from your tax return. The amount you can exclude varies, but in most cases, you can exclude the lesser of $10 million or 10 times the adjusted cost base (that's the price you paid for the stock minus any additional fees that have been incurred). Simply put, if you buy a QSBS for $100 and you sell it for $900, you have a gain of $800. In this case, you can exclude up to $1,000 in gains (the cost $100 times 10) so you don't have to pay tax on the $800.

How to Invest in Small Businesses

1. Buy Your Own Business

If you've got a dream, it may be time to turn it into a reality. Opening your own small business is a great way to invest in yourself and potentially turn a passion into a career. While there are a lot of low-cost business ideas, other concepts need some start-up capital.

Getting loans from banks is easier than it has been for about a decade. Unfortunately, approval levels are still relatively low. Luckily, there are several fintech companies and alternative lenders who offer small business loans or lines of credit to aspiring entrepreneurs, and because these lenders use different risk models, that makes it easier for small businesses to access the funds they need.

2. Engage in Equity Financing

Instead of investing in your own company, you may want to invest in someone else's dream. Even very small companies can set up equity financing deals if they have the right financial consultant in place to advise them on how to set up the transaction.

In this type of investment, you give or lend money to a start-up. In turn, you own a small piece of the company. In most cases, there are limits on when you can cash in or sell your stock.

3. Peer Lending

Peer lending is similar to equity financing, but it's a lot simpler. Businesses don't need to set up complicated financial instruments. Rather, they just borrow money as they would from a bank. However, rather than borrowing the funds from a financial institution, they borrow funds from people like you.

To become an investor on a peer-to-peer lending site, you put aside a bit of capital. Then, you identify borrowers who look promising. You offer to loan them money, and when it gets paid back, you earn interest.

Investors can overlook small businesses, but they’re a great way to diversify your portfolio. With small businesses, investors have a variety of ways to invest – from ownership to direct investments. Small businesses are great for the economy, for your taxes and for the American dream. Using the tips above, why not start investing in your local small business?