As we, SMG Consulting Group, begin our 2015 tax preparation season, one of the most common questions we get each year is “how or where can I invest the cash from my tax refund?” Some folks are hesitant to make the traditional investments into stocks, bonds, mutual funds, etc because of the Wall Street scammer stories. Other clients are interested in real estate. But, they realize real estate has become an investment that may require a substantial cash down payment as well as maintaining a notable cash reserve for any unforeseen incidents. Now it is not being promoted that the stock market and the real estate industry are bad investments. However, it is our intention to offer an alternative investment option. That alternative investment option is investing into small businesses.
With the job market being so uncertain, more individuals are looking to create their own source of revenues by becoming entrepreneurs or they have no other options but to start a business venture to generate some income. These newly created small businesses are increasing in numbers and their growth potential can be stymied due to the lack of capital and/or the strict lending requirements of the banks today. Yet, these businesses can benefit tremendously from cash infusions ranging from $5,000 — $50,000. These small business investments can yield double digit return on investment. Here are some of the suggestions we make when considering investing into a small business.
Create a Tax Savings Business Entity — This is the first recommendation. The reason why is because it leverages your cash investment in several ways, especially if you are maintaining a job. If you are willing to make an investment of $10,000, you should make the first deposit into your own business entity’s bank account. Then, the business entity would make the investment into the small business. By having your own business entity, any expenses associated with you exploring investments and/or managing your investment can possibly be recorded as an expense, which in the tax world expenses reduce taxable income; expenses such as travel, meals, cell phone, etc. These expenses can be either recorded as a loss, which can reduce your taxable income.
An alternative option can be to defer the expenses by recording the initial investment into your company equity account. Let’s simply define the equity account as the balance the business entity owes the owner. For example, your initial investment of $10,000 is part of your equity account. If you incur an additional $5,000 in expenses, you can add that to your existing equity account balance, which will take your total equity account to $15,000. This means you can withdraw up to $15,000 out of your company with possibly no tax consequences (Consult with your tax advisor on your current tax situation).
Develop an advisory board — Put together a group of peers that you are comfortable with helping you make decisions. That group can consist of friend(s), family member(s), an accountant, an attorney, or SMG Consulting Group. With the success of the show Shark Tank, create your own team of sharks that will help you evaluate a potential investment into a small business.
Perform your own due diligence — Now that you have your advisory board, you and your board make sure to conduct a solid investigation into any prospective small business. One main criterion is to evaluate the small business infrastructure to determine if the business model is viable and if the business can sustain in order to be able to, at least, pay back your initial investment.
Make Sure you have a Voice — Take into consideration that the best investments are the ones you play a significant role. Therefore, prior to making an investment, identify how you can help out the business venture, whether that is being on an advisory board, finding new customers, and/or making a key connection for the business. More importantly, stay active on the business, which means understand what’s going on and monitoring the progress of the business. This kind of participation can help you establish your entrepreneurial identity as well as protect your investment.
Manage your Expectations — Every investment will not generate a Facebook return on investment (ROI). The goal is to receive a ROI that is higher than the other traditional investments and definitely higher than what todays banks’ interest rates pay out. In the event you invest $10,000 and you get back a total payment of $15,000 (Principal & Interest) that’s a 50% ROI. Not too many investments out there yielding that kind of ROI.
Invest into the Management Team — Get to know the people running the company. Make sure they demonstrate their passion for their business venture as well as bring you comfort by being able to clearly define and exhibit the company’s business objectives. Keep in mind, once you make the investment, these are the individuals you are establishing, possibly, a long term business relationship.
Conclusively, like any investments, there are no guarantees and there are risks involved in investing in small businesses. However, we tend to believe the pros out way the cons. When you perform your own evaluation, you are minimizing your risk, and you will probably see a higher return on investment than the traditional investments’ yield.
Good luck with small business investing!
Gary Stephens is Managing Partner of SMG Consulting Group, LLC a full service consulting firm that inspires entrepreneurship, business development, and building wealth through business ownership.