Estimated reading time: 8 minutes
Americans might have mixed feelings about Wall Street, but it’s safe to say we love Main Street.
In fact, 86% of U.S. adults say small businesses have a positive impact on the country — making them the most trusted institution in America.
Small businesses are a quiet powerhouse in the U.S. economy, employing over 56 million workers and generating $16.2 trillion in revenue. They’re also responsible for the majority of job growth. But if you’re looking to invest in these businesses, you won’t find them on the S&P 500 — you’ll need to explore the private markets.
Investing in small businesses offers a unique opportunity to tap into high-growth potential, diversify your portfolio, and make a positive community impact. Unlike large corporations, small businesses can experience rapid early-stage growth, delivering significant financial returns while driving innovation and job creation in local communities.
In this guide, we’ll cover everything you need to know about investing in small businesses — from the types of investments available, how to find opportunities, and the potential pros and cons of investing in mom-and-pop shops in 2025.
Table of Contents
- Types of Small Business Investments
- How to Find Small Business Investment Opportunities
- Potential Rewards of Investing in Small Businesses
- Risks of Investing in Small Businesses
- Invest in Small Businesses While Lowering Your Tax Liability
Types of Small Business Investments
First, let’s explore the three primary types of small business investments: equity, debt, and hybrid investments.
Equity Investments
An equity investment involves buying a stake in a small business in exchange for ownership shares. As an equity investor, you share in the business’s success (or failure) based on its performance and growth.
Common examples of equity investments include:
- Angel Investing: Providing capital to startups in their early stages in exchange for equity.
- Venture Capital: Investing larger amounts of money in growing businesses with high potential for returns.
- Crowdfunding Platforms: Websites like StartEngine, WeFunder, and Republic allow investors to purchase equity in small businesses through online platforms.
Pros of Equity Investments:
- High Return Potential: If the business grows and becomes successful, your equity stake can significantly increase in value.
- Influence on Business Decisions: In some cases, equity investors may have voting rights or influence over key business decisions.
Cons of Equity Investments:
- High Risk: There’s a risk of losing your entire investment if the business fails.
- Illiquidity: Equity investments in small businesses are typically illiquid, meaning you can’t easily sell your shares or withdraw your investment.
Debt Investments
A debt investment involves lending money to a business in exchange for regular interest payments. Unlike equity investments, you do not own a portion of the business. Instead, you’re acting as a lender with a promise to be repaid according to the agreed terms.
Common examples of debt investments include:
- Small Business Loans: Providing loans directly to a small business, often secured by collateral.
- Peer-to-Peer Lending Platforms: Websites like LendingClub and Funding Circle connect investors with small businesses seeking loans.
Pros of Debt Investments:
- Regular Income: Debt investments provide steady, predictable interest payments, which can offer a reliable income stream.
- Lower Risk: Compared to equity investments, debt investments are generally considered lower risk, as you’re entitled to be repaid before equity holders if the business fails.
Cons of Debt Investments:
- Limited Upside: Unlike equity investments, debt investments don’t offer unlimited growth potential. Your returns are limited to the agreed interest payments.
- Default Risk: There is always a risk that the business will default on the loan, leaving you without repayment.
Hybrid Investments
Hybrid investments combine features of both equity and debt. These options offer greater flexibility and different risk-reward profiles depending on the terms of the agreement.
Examples of hybrid small business investments include:
- Convertible Notes: A loan that can convert into equity at a future date, often during a future funding round. This allows investors to start as lenders but potentially become equity holders if the business grows.
- Revenue-Based Financing: Instead of receiving fixed interest payments, investors receive a percentage of the business’s future revenue until the loan is repaid.
Pros of Hybrid Investments:
- Flexibility: Hybrid investments offer greater flexibility, allowing you to benefit from both debt and equity features.
- Upside Potential: Convertible notes, in particular, offer potential for equity-like returns if the business performs well.
Cons of Hybrid Investments:
- Complex Terms: Hybrid investments can have complex agreements, making them harder to understand for inexperienced investors.
- Risk of Loss: As with any small business investment, there is always a risk of losing your capital if the business fails.
How to Find Small Business Investment Opportunities
Here are four key avenues to find small business investment opportunities:
Personal Network
One of the easiest and most reliable ways to find small business investment opportunities is through your personal network. Friends, family, and local business owners can be excellent sources of opportunities, particularly if you already have relationships built on trust.
Small business owners often seek funding from people they know before turning to formal investors. If you’re interested in supporting a local business or helping someone you trust get their venture off the ground, your personal network is a great starting point.
Online Platforms
The rise of online crowdfunding and peer-to-peer lending platforms has made it easier than ever to invest in small businesses. These platforms connect entrepreneurs with investors, allowing you to browse a wide range of business opportunities from the comfort of your home.
Some platforms offer equity investments, while others focus on lending opportunities. Many of these platforms provide detailed business information, financial projections, and even investor perks.
Local Business Networks
If you prefer a more hands-on approach, consider attending local business events to connect with small business owners and entrepreneurs directly. Small business associations, Chamber of Commerce events, and local meetups are excellent venues for finding businesses seeking investors.
These events allow you to build relationships with local entrepreneurs, gain firsthand insight into their operations, and learn about their funding needs.
Angel Investor Groups
If you’re looking for structured investment opportunities, consider joining an angel investor group. These organizations connect high-net-worth individuals with small businesses seeking funding. Angel groups often focus on early-stage businesses and startups with high growth potential.
Angel investor groups provide members with access to curated investment opportunities, due diligence reports, and educational resources to help them make informed decisions.
No matter where you start, always conduct thorough due diligence to ensure the business aligns with your investment strategy and risk tolerance.
Self-Directed IRA Due Diligence Guide
Potential Rewards of Investing in Small Businesses
While small business investments offer exciting opportunities for growth and impact, they come with unique challenges that every investor should understand before committing funds.
High Returns
One of the biggest appeals of investing in small businesses is the potential for high returns. Unlike established corporations, small businesses often experience rapid growth in their early stages, which can translate into significant financial gains for investors. For example, a small startup you invest in today could grow into a major industry player, multiplying your initial investment several times over.
While not every investment will achieve these results, those that succeed may deliver returns far exceeding traditional investments like stocks or bonds.
Portfolio Diversification
Investing in small businesses allows you to diversify your portfolio beyond traditional asset classes, such as stocks, bonds, and real estate. This diversification can reduce your overall risk by spreading your investments across different sectors and industries.
Small business investments are also less correlated to the stock market, meaning they may perform better during times of market volatility. By including alternative assets like small businesses in your portfolio, you can create a more resilient investment strategy that isn’t solely dependent on public markets.
Impact Investing (Supporting Local Communities)
Small business investing isn’t just about potential profits — it’s also an opportunity to make a positive impact on local communities. By funding small businesses, you’re supporting entrepreneurship, job creation, and innovation.
Many investors find fulfillment in knowing their capital is helping a business grow, creating jobs, and contributing to economic development. This type of impact investing is becoming increasingly popular, especially among investors looking to align their financial goals with their values.
Risks of Investing in Small Businesses
While the potential for high returns and meaningful impact is significant, it’s important to fully understand the risks involved as well.
Business Failure
The biggest risk of small business investing is business failure. According to the U.S. Small Business Administration (SBA), over 30% of small businesses fail within the first two years, and 50% fail within five years.
Unlike investing in established companies with proven track records, small businesses often operate in uncertain markets or rely heavily on new products and services. This risk of failure means investors must be prepared to lose their entire investment if the business doesn’t succeed.
Illiquid Investments
Small business investments are typically illiquid, meaning they cannot be easily sold or converted into cash. Unlike publicly traded stocks, there’s no open market to sell your shares in a small business, and you may need to hold your investment for several years before seeing any returns.
This lack of liquidity can be a challenge for investors who need quick access to cash or prefer more flexible investments. It’s important to approach small business investing with a long-term mindset and ensure you won’t need those funds in the near future.
Long Time Horizon for Returns
Small business investments often have a long time horizon before generating returns. It can take years for a business to achieve profitability, and investors need to be patient during that time.
This long wait for returns can be frustrating, especially for those used to more immediate results from traditional investments. However, for those willing to take a patient, long-term approach, the rewards can be well worth the wait.
Invest in Small Businesses While Lowering Your Tax Liability
Investing in small businesses can be a powerful way to diversify your portfolio and achieve long-term growth.
With a self-directed IRA (SDIRA), you can take this a step further by using your retirement funds to invest in privately held companies while enjoying tax advantages that come with a traditional or Roth IRA.
Unlike an IRA held at a bank or brokerage that limits investment options to public securities, an SDIRA gives you the freedom to invest in private companies, startups, partnerships, and more — as long as the investment complies with IRS rules.
Here’s how the process works:
- Open an SDIRA: All you need is 10 minutes of your time and a copy of your government-issued ID.
- Fund the account: Move cash into the account using an existing IRA or 401(k), or make a cash contribution.
- Choose a small business investment: Make sure to conduct thorough due diligence to assess the business’s financials, leadership, and market opportunity before making a commitment.
- Submit a Buy Direction Letter: Whether you complete the paper form or digital form through the Entrust Client Portal, this form instructs Entrust to invest in the business on behalf of your IRA.
That’s all there is to it.
Plus, if you become an Entrust client, you gain exclusive access to Entrust Connect, our online investment marketplace that’s constantly updated with new small business opportunities from real estate projects to burgeoning startups.
Want to learn more about SDIRAs? Download our free SDIRA Basics Guide. Inside, you’ll find a comprehensive breakdown of the IRS rules, examples of what you can and cannot invest in, and a step-by-step process to get started.
Note: The content provided here is for informational purposes only and should not be considered financial, tax, or investment advice. Always consult with a trusted tax or financial advisor to determine what is best for your unique situation.
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