Investing in small businesses?

[Curmudgeon]

Any of you folks ever invest in small businesses? For example, I'm a craft beer lover, and I often see small breweries looking for investors to help fund startup or expansion. So we're not talking stock ownership here, but other - highly customized, I'm sure - financial arrangements. I don't think I'd do it with anything but my 'play around' money, but I'm wondering if anyone has done similar investments and have experiences to share - good or bad - or things to watch out for in terms of financial arrangements.

 

[braumeister]

Very high risk ventures.

Last time I saw the numbers, it was something like for every seven breweries that open in this country, four close.

So there is constant growth in the industry but every case has to be evaluated on its own merits.

 

[OldShooter]

Any of you folks ever invest in small businesses? For example, I'm a craft beer lover, and I often see small breweries looking for investors to help fund startup or expansion. So we're not talking stock ownership here, but other - highly customized, I'm sure - financial arrangements. I don't think I'd do it with anything but my 'play around' money, but I'm wondering if anyone has done similar investments and have experiences to share - good or bad - or things to watch out for in terms of financial arrangements.

In Olden Times this was done via private placements. Qualified investors meeting certain financial qualifications could buy stock in a venture or a small company. There was a fat, legalistic, "offer letter" and an slightly skinnier "subscription agreement" to be dealt with. The stock was restricted and could not be traded. Shareholders simply waited it out until the company was sold or went public.

We invested in a number of them and most were profitable. A couple were huge moneymakers. One restaurant deal reduced $50K to zero in a little over a year, though. We never did a deal where we didn't know the principals personally or via local reputation.

These days there are some new, simpler, methods for raising money. I was recently shown a solar energy deal where the number of investors was very limited and there were other requirements but the net worth/income requirements for private placements were not there and the whole offering process was simple and very low key.

Good deals can be found via word of mouth; your CPA, attorney, etc. The offer letters are simple and you'll deal with one of the company principals during your due diligence. Stinky deals come from brokers and are offered via four-color brochures. Don't even think of going there. Any deal that is offered to you by a broker is one that is either so stinky that the broker's regular customers have already rejected it or so stinky that he doesn't dare pitch it to them.

Breweries? I wouldn't touch 'em with a stick. In our market there are literally hundreds with tap rooms. A major shakeout is as certain as sunrise.

 

[CaptTom]

Breweries? I wouldn't touch 'em with a stick. In our market there are literally hundreds with tap rooms. A major shakeout is as certain as sunrise.

I'm not qualified to give investment advice, but personally, I'd stay away from anything that's a fad. In our area, breweries are "out" and distilleries are "in."

Next year it'll be something else.

 

[Curmudgeon]

To be more clear, my question isn't specifically about breweries. I've been watching this particular sector for over 30 years now, so I'm familiar with the ups and downs. (And, I would point out, people are generally about as good at predicting the peaks and valleys of this industry as they are at predicting the peaks and valleys of the Dow. )
I'm more interested in what to look for when investing in any small business in general, where you're dealing directly with the principals - as opposed to buying stock on an exchange. Brewing is just a specific case where I see offers all the time, because of the crowd I run with.

 

[haha]

To be more clear, my question isn't specifically about breweries. I've been watching this particular sector for over 30 years now, so I'm familiar with the ups and downs. (And, I would point out, people are generally about as good at predicting the peaks and valleys of this industry as they are at predicting the peaks and valleys of the Dow. )
I'm more interested in what to look for when investing in any small business in general, where you're dealing directly with the principals - as opposed to buying stock on an exchange. Brewing is just a specific case where I see offers all the time, because of the crowd I run with.

If you are sure that you will be as clever at stealing from the owner-managers as they will be at stealing from you, no worries.

Ha

 

[Sunset]

All businesses sound good, most fail.
After you blow your play money, then you won't get to play anymore

 

[Texas Proud]

I invested in a small company where I worked... it is an S corp that is pretty specialized in software...


One of the problems is that you probably have so little of the stock you have zero say in what happens... I own less than 2% and have zero say... over 50% is owned by the founder and another 35 to 40% or so by two people he knew when it started...

When I invested they had a 100% dividend policy.... but the owner wanted to buy a building for the company and had the agreement amended that lowered it to 25% (it was 50% minimum).... so the 'value' of the stock went way down IMO... well, at least to me.... what the company holds back is not adding value to the shares...

Now, the only thing I can hope is that the building actually starts to make money... he bought one that was much larger than needed and it has tenants... I doubt that the company will grow to the full building so we will start to get some rent... and appreciation since it is in a growth spot...

Now, like you this is a bit of 'play money', and if it went to zero it would not hurt too bad.... but it is a good chunk of change to me...

 

[Onward]

I've been dabbling in investing in startups at these sites:

StartEngine

SeedInvest

CircleUp

It's way too early to expect any kind of return yet.

I don't even begin to pretend that I can pick eventual winners, so my strategy is to diversify widely.

I guess this is my version of buying lottery tickets.

 

[Curmudgeon]

When I invested they had a 100% dividend policy.... but the owner wanted to buy a building for the company and had the agreement amended that lowered it to 25% (it was 50% minimum).... so the 'value' of the stock went way down IMO...

Seems like if you had an agreement that in exchange for your investment you would get (your share of) 100% dividends, then they shouldn't be able to do this... What kind of written agreement, if any, did you have with the owners?

 

[Texas Proud]

Seems like if you had an agreement that in exchange for your investment you would get (your share of) 100% dividends, then they shouldn't be able to do this... What kind of written agreement, if any, did you have with the owners?

OH, I get my share.... at least all shares get equal per share amount..

They used to dividend 100% of the profits to the shareholders... now it is only about 50% as they are 'trying to build capital'... the original agreement was 50% but it was lowered to 25% last year... but when I bought they had been doing 100% dividends for over 20 years...

So, they did not break any written agreement, just historical norms...

 

[daylatedollarshort]

I've only invested in my own small businesses, and that worked out great. Most of the managers I worked with when I had a megacorp job weren't stellar at managing project budgets or their own personal finances, even though they all had college degrees and training in project management. As such, I would have a hard time trusting a random small business owner to be any better, and likely even worse, than my former co-workers with any of my investment funds. Plus as someone else mentioned the failure rate on small businesses in general is pretty high. It would have to be a unique situation to me where I knew the owners and their financial and business skills very well to give a small business any of my own money.

 

[Winemaker]

As an aside, it is usually smarter to have a different entity purchase the building and lease it to the business. The entire lease payment is deductible, and no liability to have a lawsuit or lien placed upon.

 

[Bruceski44]

I invested in business loans via Funding Circle, whose loans are secured by the business assets and a personal guarantee (which is something more than it sounds like.) I got 10% for a year, then there was a spate of defaults which ate all my gains. FC has been operating in the UK for quite a while, but the US operation has disappointed me.

Now I'm participating in business loans to Veteran-owned businesses via StreetShares, which pay 5% on their business bonds. I think you can also make fractional loans via another section of their site. 5% isn't bad when you consider the alternatives and I like helping other Vets.

Both portals are restricted to accredited investors. You can reduce the risk by making smaller loans to a variety of businesses, instead of a single, bigger loan to one.

 

[Texas Proud]

As an aside, it is usually smarter to have a different entity purchase the building and lease it to the business. The entire lease payment is deductible, and no liability to have a lawsuit or lien placed upon.

It is a separate legal entity that is owned by the S corp.... not sure this is the best way but it at least does not cause conflict...

The owner had thought about having it a separate business, but he is pretty honest and did not want to create a conflict with the rents...

 

[OldShooter]

@Curmudgeon, I'll give you a few answers from my experience, but understand I have not invested in any deals under the new, looser, subscription rules. Only the old private placement rules: (https://www.sec.gov/oiea/investor-alerts-bulletins/ib_privateplacements.html)

RE "what to look for" my approach has always been to invest in people. To do this I need to know the people personally, maybe after meeting and talking with them in connection with the deal. Ideally, we have mutual friends. The one time I didn't do this I relied on the reputation of a local restaurant group who had a string of very successful restaurants. I never did meet any of them directly. That was the $50K that went down the toilet.

After being satisfied with the sellers, I do look at the business proposal. It has to be a business I understand and the thinking has to make sense to me. But the sellers are the experts, they are putting their blood and treasure into the deal, so if they don't know more than I do, why am I here? (If they are not putting blood and treasure into the deal, I am already gone.)

My wife and I were pitched by a professional friend of hers who wanted to start a bank. It was very convincing but I declined because I don't know how to read bank financial statements and I really don't understand the risks in the business. He went on to do very well and I think we would have profited but I am completely comfortable with sticking to my decision to only buy things I understand.

Re what are you buying, in my case it was always a minority share of stock. In the deals I saw, the company founders always kept enough to have controlling interest. So it went back to trust, because the majority can screw the minority shareholders pretty badly if they choose to. There are state laws that protect us, but those laws and $20K in legal fees are probably the minimum ticket for redress.

Re funding sites like @Onward mentions, the only sure thing about what is offered there is that the sellers have been unable to get the deal funded locally. Probably because it is a stinky deal, maybe because they are inept or unqualified in the financial aspects of what they are doing. Viewed as lottery tickets, I think the sites could be a lot of fun. Viewed as an investment, not so much. I never buy lottery tickets, so I won't be following @Onward's path, but I think he/she has made an accurate assessment of the risks and hope he/she enjoys the rides.

 

[jjim6954]

Angel investments are the worst asset class available. You're better off going on a vacation with your playing around money. I've been a member of some angel groups. I've never invested, but I have watched tens of millions go down the toilet. This helps to illustrate the issues:


https://www.financialsamurai.com/just-say-no-to-angel-investing/

 

[FIREd]

We were approached a couple of months ago by a local biotech startup looking for new investors. DW reviewed the science (her field of expertise) and thought, with proper guidance, it had potential. I reviewed the finances and vetoed the deal.

They wanted us to become minority shareholders so we'd have had little say in the running of the company. Plus there was the potential for our shares to be further diluted in subsequent funding rounds. Their valuation was way off too, I thought. They were running low on cash and their only physical asset was used lab equipment. I have seen enough biotech companies going belly up to know that used lab equipment does not fetch a lot at auction. I understand that the company is their "baby" and that it is tempting to think that it is worth more than it truly is, but it told me that they did not have a firm grasp on reality.

Also, the company was built with daddy's regular cash infusions. I got the feeling that the old man wanted his money back and that's where we came in... We offered some advice to improve the business (free of charge) but all they wanted was $$$. Pass...

 

[OldShooter]

Angel investments are the worst asset class available. ...

All true. That's why I start by making sure I know the principals at a personal level. I'd never get into a deal after VCs have been there.

We were approached a couple of months ago by a local biotech startup ...
Also, the company was built with daddy's regular cash infusions. I got the feeling that the old man wanted his money back ...

Funny. Other than the daddy's money thing, most of your story could be describing any one of several successful deals I've invested in. It's always minority stock. They are never interested in any advice. There is never any collateral. It always looks overpriced. In the end, it's the people and your faith in their honesty, competence, and probability of success. The "daddy's money" part would make me very wary though.

Re web sites offering personal guarantees and business assets as security. I would want to know who pulls the trigger on defaults, who does the collection work, and how much will be lost to fees. I suppose that the web site could have a workout department like a bank would have, but that costs money. If no workout strategy, are the guarantees and collateral really there if the deal bubbles?

 

[Blue Collar Guy]

Now, the only thing I can hope is that the building actually starts to make money... he bought one that was much larger than needed and it has tenants... I doubt that the company will grow to the full building so we will start to get some rent... and appreciation since it is in a growth spot...

Now, like you this is a bit of 'play money', and if it went to zero it would not hurt too bad.... but it is a good chunk of change to me...

Can you sell him back the shares?

 

[Texas Proud]

Can you sell him back the shares?

Not really.... he owns a few hundred acres and has cattle... that cost him about $100K per year in cash flow... plus all the other expenses of his house... the guy is rich, but cash poor....

They did an eval on the price and it is valued at 70% of what I paid... but that has a HUGE discount rate and also a minority haircut... nobody wants to sell at this low price so you know it is wrong...

I am happy holding on as I think that it will pay for itself in the long run and my yield is 5.8% on my investment at the current divi... the big problem is that some years are great and some not... my best year was over 16% but the worst was less than 1%...

Just looked and the shares that I bought in 09 has already paid for themselves... I paid more for the next few rounds and have gotten back about half...

 

[RenoJay]

I think one of the big issues with start up investing is compliance. Waiting for K1's (which are always late in my experience) can delay/mess up your personal tax filing.