Investing in a small business is quite different from investing in the stock market, a fund, a startup, or a large corporation. For many investors, MainVest may be the first time they’re engaging with a small business owner in this way. It’s important to remember that investing in small businesses contains risk (as all investment does) but there are unique benefits as well.
The Revenue Sharing Note
A revenue sharing note is an agreement between an investor and a business. The business agrees to share a percentage of their future revenue until their investors receive a return on investment. This can be hugely beneficial for small business owners, who may struggle with fluctuations in cash flow throughout the course of a year. It also provides an opportunity for investors to impact their own returns to an extent, as they can choose to patronize the business in which they’ve invested, increasing revenue, and potentially, their own rate of return. As a debt security, the revenue sharing note will work a bit differently from traditional investments. The returns are capped, and there is a risk that a business will never generate revenue, or not generate enough revenue, to complete the full return. However, investors seeking straightforward, easy to understand terms with a clear maturity date within 5-8 years may find revenue sharing notes appealing.
Working with small business owners
Investing in small business owners can be rewarding, but may present unique challenges as well. Investing locally gives investors the chance to get to know the business owner on a personal level and build a meaningful relationship. Investors may gain an emotional benefit from knowing that they’re supporting a local entrepreneur: there’s something to be said for becoming a “regular” at a local business, and knowing the person providing services. However, investors should be aware that small business owners typically have a lot on their plates. Whereas traditional investment firms and large corporations have entire teams dedicated to investor relations, small business owners may only have themselves, and maybe an HR or marketing manager on staff to help out. Small business owners may not be as fast to respond to investor matters as investors may expect due to the demands of their business. In many cases, the revenue sharing note may be the first experience that a business owner has with investors as well, and may not share the same vocabulary or expectations with that of an experienced investor.
Understanding small businesses
Small businesses are important aspects of communities, and the new regulations that allow investors to invest in them through funding portals like MainVest have provided countless local entrepreneurs a new pathway to capital. Small businesses provide a sense of local pride and make neighborhoods vibrant and unique. And while common beliefs such as “99% of restaurants fail in the first year” are actually exaggerated, small businesses do carry unique risks, and many do fail. This is largely due to undercapitalization, something that community investment is specifically designed to prevent, but the fact remains that many small businesses struggle to generate enough revenue to make it past a couple years. Small businesses tend to run on tight margins. However, the social underwriting model predicts that community investment mitigates some of the risk associated with starting a small business. It’s important to remember that all investment is risky, and we encourage all investors to seek outside advice before starting a new investment strategy.