How to Invest in Small Businesses: Guide

Investing in small businesses can be one of the most exciting, and potentially rewarding, ways to grow your wealth. Instead of buying shares in large public corporations, you’re backing entrepreneurs, new ideas and companies that may still be in their early stages of growth. But with that opportunity comes greater risk, less liquidity and fewer regulatory safeguards. Before you commit capital, it’s essential to understand how small business investing works and whether it fits your overall financial strategy.

A financial advisor could help you create a financial plan to protect your investments and identify new opportunities to make money.

Small Business Investing Basics

There are more than 31.7 million U.S. businesses with fewer than 500 employees, according to the Small Business Administration. This group of enterprises, which represent more than 99.9% of all companies, has little or no ability to raise capital by selling equity on the stock market or issuing debt instruments for the bond market. Instead, they typically finance operations and growth with the help of bank loans and investments from the founders.

Just as small businesses are largely absent from the securities markets, investors are much less likely to put money into small firms than into large, publicly traded ones. However, small businesses can represent attractive opportunities to diversify out of conventional asset classes and sometimes gain outsized returns.

Small Business Investing Opportunities

SmartAsset: How to Invest in Small Businesses: Guide

Small business investing can take several forms, depending on how much capital you want to commit and how involved you’d like to be. From direct ownership stakes to more passive structures, each option comes with its own risk profile, return potential and level of control. To tap these opportunities, investors have to overcome sizable challenges. Those include:

Identifying the relatively few small businesses that are suitable for investments,
Accepting the likelihood of losing much or all their money due to the high inherent risks of the asset class,
Waiting long periods up to several years to cash in without access to their invested funds and,
Finally, working within federal regulations limiting the amounts they can invest.

Small business investments can take the form of equity or debt. Equity involves buying an ownership stake in the company in exchange for an infusion of capital, much like purchasing shares of a public company on the stock exchange. Debt investing is similar to giving the company a loan that will be paid back with interest. Variations include convertible debt securities that can be changed into shares of ownership, as well as equity investments that pay dividends.

Small businesses are not suitable investments for everyone, and this is not just an axiom but an official government rule. The Securities and Exchange Commission allows only accredited investors who meet certain wealth, income and knowledge guidelines unfettered use of Instead, crowdfunding portals, one of the most popular ways to invest in small business.

Non-accredited investors with annual income or network less than $107,000 can only invest up to $2,200 or 5% of their net worth in any 12-month period, according to the SEC rule. Those with over $107,000 in income and net worth can invest up to 10% of income or net worth, whichever is less.

How To Invest in Small Business

In contrast to the ease and simplicity of buying shares of mutual funds with holdings selected by financial analysts and fund managers, or even shares of individual public companies, small business investing is much more involved and unstructured. Information about small, private companies is harder to come by, and much of the job of evaluating opportunities has to be done by the individual investor.

Small business investors must first identify suitable opportunities among the millions of potential investments. Then they do their own due diligence, examining financial statements, interviewing company executives and evaluating market size and competitive challenges. Finally, they have to negotiate with the business about how to price equity shares, how much to charge for loans and other terms of the deal.

Small Business Crowdfunding

Over the last several years, in response to relaxed federal regulations, crowdfunding has become a popular way to invest in small businesses. Websites such as Mainvest and WEfunder accept applications from small businesses and vet them before offering them to investors.

Investors on crowdfunding sites can start with as little as $100. And they can receive regular financial updates much like quarterly and annual reports from public companies. The crowdfunding services also collect repayments from small businesses and distribute them to investors.

Pros and Cons of Small Business Investing

Investing in small businesses can offer the potential for strong returns and a chance to support entrepreneurs directly. Whether you’re funding a local startup, buying equity in a growing company or participating through online platforms, small business investing differs significantly from traditional stock or bond investing. Understanding the advantages and trade-offs is essential before committing capital.

Pro: High Growth Potential

Small businesses often have more room to grow than established corporations. If you invest in a company that scales successfully, your returns can significantly outpace those of more traditional investments. Early-stage investments, in particular, may offer outsized upside if the business expands rapidly or is acquired.

Pro: Diversification Beyond Public Markets

Small business investments can diversify your portfolio beyond publicly traded stocks and bonds. Because private businesses don’t always move in tandem with broader market trends, they may reduce overall portfolio correlation. This can provide an additional layer of diversification, especially for investors with significant exposure to public markets.

Pro: Direct Impact and Engagement

Investing in a small business can offer more than financial returns. Many investors appreciate the opportunity to support local entrepreneurs or innovative ventures they believe in. In some cases, you may also have a more direct relationship with the business, providing input or expertise.

Con: Higher Risk of Failure

Small businesses carry a higher risk of failure compared to established public companies. Limited operating history, competitive pressures and cash flow constraints can lead to significant losses. Unlike diversified mutual funds or ETFs, a single business investment can result in a total loss of capital.

Con: Limited Liquidity

Private small business investments are typically illiquid. Unlike stocks, which can be sold quickly on an exchange, it may be difficult to exit your position until the company is sold, goes public or distributes profits. This means your money could be tied up for years.

Con: Less Transparency and Regulation

Public companies are required to provide regular financial disclosures, but small private businesses may offer less standardized reporting. Investors often rely on management projections and limited documentation. Conducting thorough due diligence is critical before investing.

Small business investing can be rewarding, but it requires a higher tolerance for risk and a longer time horizon. Balancing potential growth with careful vetting and diversification is key. A financial advisor can help determine whether small business investments fit within your broader portfolio strategy and long-term financial goals.

Bottom Line

Small business investing offers the chance to get higher returns and have a bigger impact than investments in other asset classes like stocks, bonds and real estate. However, the risks of losing the entire amount invested are high. With small firms, and it can take years for a small business investment to pay off. Crowdfunding sites can give an investor a chance to look at lots of small businesses that have already been vetted. However, federal regulations limit how much most investors can commit to these opportunities.

Investing Tips

No matter how you want to invest your money, a financial advisor can help you make the right decisions. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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