Types of Investments You Can Make in a Small Business
If done right, investing in a small business can be a true money machine. This is one of the most powerful ways to unleash your entrepreneurial spirit and, at the same time, boost your cash flow and gain financial independence.
Now, it doesn’t matter if you want to launch a new startup or buy into a business that already exists, there are a few types of investments you can make.
Let’s check them out!
When you buy an ownership investment, you’re actually becoming a partial owner of a business. The idea behind all this is pretty simple- an equity investor provides cash in exchange for getting a percentage of the company’s profits. When the value of the investment grows or goes down, you share the profit or the loss with other investors.
Since you own a portion of a company, your opinions will also be vital to making some important decisions about its future. For example, you can vote for the board members or propose your ideas concerning the organization’s operations.
Now, there are different types of equity investments.
Starting a business is, for instance, an example of an ownership investment. By putting your money into launching a business and creating a product people want to buy, you can generate massive returns. Microsoft’s founder and one of the richest people in the world, Bill Gates, is a perfect example of this.
Stocks, also called an equity or a share, are also a form of equity investment. Once you create a term sheet and negotiate the binding terms, shares will confirm that you own a portion of a certain business. They give you the right to a part of the company’s value, as well as allow you actively participate in the company’s operations. When buying into a business, it’s immensely important to draft a shareholder agreement that will protect your rights, as well as the rights of other stockholders.
Logically, your profit, in this case, depends on the company’s value. For example, if the company you’ve invested in drives a record profit, other investors will want to have its shares, too. And, as the demand for shares rises, it increases the price of shares and you can boost your profit if you decide to sell them.
What makes an equity investment popular is that is can result in gigantic gains. But, everything that is highly profitable is risky, too. First, no one can guarantee you that the price of your investment will stay the same or grow in the future. It can go down, as well. The same goes with your earnings. There are no guarantees that there will be any profits. These are all aspects of a business that are highly affected by some outside factors like some economic changes, political situations, etc.
When you make a lending investment, you’re buying a debt that needs to be repaid. So, you act like a bank. This form of investment is much safer and less risky, when compared to equity investments, but your ROI will also be significantly lower.
The most prominent type of lending investments is debt investments. Simply put, when a company needs money, it issues a debt. In other words, they sell their bills, notes, and bonds to investors to get the money needed to grow. And, an individual or an institution buying the bond is a lender, responsible for providing the issuer with the right funds.
Of course, a company needs to agree that they will pay back the debt in the future. What’s great about a debt investment is that it has priority over the equity investors. This means that, even if the company goes broke in the future, you will have a higher claim of any of its assets, compared to shareholders.
Your savings account can also be seen as a lending investment. You’re lending money to a bank and it loans it out to you later.
Cash equivalents are probably the safest form of investments. This is why their return is also small, about 1% to 2%. They also serve as one of the major indicators, showing a company’s financial health and telling whether it’s profitable to invest in it or not. That being said, it’s obvious that the businesses with higher cash equivalents are primary targets for larger corporations that want to acquire them.
Now, there are 5 types of cash equivalents:
- Treasury bills (T-bills) are short-term government bonds or debt securities.
- Commercial papers are unsecured debts issued by larger companies to cover short-term obligations.
- Marketable securities need to be redeemed within a year. They include stuff like certificates of deposits, government bonds, etc.
- Money market funds are defined by Investopedia as “an investment whose objective is to earn interest for shareholders while maintaining a net asset value (NAV) of $1 per share.”
- Short-term government bonds are allocated to different government funds.
So, these are three basic forms of investments in small businesses you can make. There is a plethora of alternative means of investment, such as real estate, commodities, or venture capital. And, as you can see from the examples given above, the most profitable investment options are those that bring the greatest risk. So, to choose the method that meets your goals, make sure you do your research properly.
And, I hope this might be a good basis for it!