Locavesting: Would You Invest in Small Local Businesses?

by JT McGee

Locavesting book looks at the next boom in small business lendingA new book titled Locavesting seeks to answer the problem of the modern small business: raising capital.

The author, Amy Cortese, is a journalist and previous financier.

I haven’t yet read the book, nor do I plan to, but I won’t let that stop me from covering this topic in full.

Amy Cortese’s plan is quite simple: redirect a small minority of dollars from “multi-national companies” that send jobs overseas and invest directly in small businesses in the US.

In theory, her plan is outstanding. If we could direct capital to small businesses, the growth possibilities for the American economy are huge.

Small Business in the United States

First things first, let’s get a few preconceived notions out of the way. Small businesses are not necessarily small companies. A small business simply has fewer than 50 employees, which, when compared to the quintessential small café shop is pretty darn big.

Additionally, small businesses play an important part of US economic production. Here are some key stats about US-based small businesses from the Small Business Administration:

  • Represent 99.7% of all employers
  • Employ over half of all workers in the United States
  • Pay 44% of US payroll in the private sector
  • Create more than half of nonfarm GDP
  • Hire 40% of all high-tech and STEM workers
  • Produce 13 times more patents per employee, which indicates innovation.
  • Generate 30.2% of the export business in 2007.

If you didn’t get the gist of those stats, the basic premise that I want to show is that small businesses are important. But according to CNN, capital available to small businesses is drying up:

Banks cut back on small business lending in 2011 so locavesting is it!

Why I like the Locavesting idea

I really like the concept of Locavesting and, despite what I’m getting from the author’s interviews about the book, it seems that Cortese realizes that the fundraising environment for small businesses is a structural problem:

  1. Fixed costs – Lawyers cost the same amount to draw up $10 million financing agreements as they do to draw up $10,000 agreements.
  2. No liquidity – There is no existing market for securities for small businesses. Under current SEC regulations, a business can have no more than 500 shareholders before going public. Plus, listing on the OTC markets requires a financial professional to serve as a market maker.

The best way to bring capital into small businesses is to open them up for investors to see. We need a new stock market that allows for direct and indirect investment in America’s small businesses. I’m totally cool with that. But to create a market like this would require an absolutely obscene amount of regulatory overhaul, which will never happen.

Peer-to-Business Lending

I think the best case scenario is to drop the barriers to individuals investing in small businesses not for equity, but for loaned capital.

According to a study published in Inc Magazine, half of small business owners surveyed tried to get a bank loan in the past 6 months. Sixty percent of loans were declined. A survey of bankers said that 72% of bankers intended to issue fewer loans in the next six months than they had in the six months previous.

Look at this chart, which shows correlation to a surge in P2P lending alongside a decline in small business bank loans:

Locavesting looks good as small business p2p lending grows.

Individuals can, and should, play a very important part in this lending process. However, as of right now, there are no good peer-to-business solutions for raising capital.

  • LendingClub and Prosper are great for P2P loans, but borrowers have to borrow in their own name, not the business’.
  • SharesPost.com operates as a fundraising and secondary marketplace for growing, VC-backed firms, but the regulatory environment requires that investors have accreditation. Accredited investors are those who have assets of more than $1 million, or annual income of more than $200,000 per year.

Structural Problems Aside

Would you invest in small, local businesses?

Would you prefer to make debt investments?

Or would you prefer to own a piece of the equity in exchange for your investment capital?

As for me, I’d be willing to invest in several small businesses around my area. Considering that valuations for small businesses are often in the 3-5 years’ earnings category, that’s a return of 20-33% per year, a return well worth the risk, in my view.

Photo by: TBoard.

{ 20 comments… read them below or add one }

ImpulseSave August 17, 2011 at 08:36

Thanks for sharing this and for giving us some graphics this is quality stuff. I’m all for locavesting. Not only does it nurse the economic health of your community but many of these small businesses are what make our communities unique. And (sigh) as a small business we are biased BUT almost all of our support is P2P investing and we’d love a system in which we don’t have to wonder where our next investor is coming from. So, we firmly believe you should make this micro-market happen!!

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JT McGee August 17, 2011 at 10:54

I wish I could make it happen. Unfortunately, the reality is that creating a market for less than liquid securities is easy…tackling the regulations to go from idea to product isn’t so easy.

Companies that trade OTC on the Pink Sheets are relatively easy to set up. You need only a single broker to serve as a market maker. However, publicizing the investment and drumming up support for a PS stock isn’t so easy. The brand is tainted. Besides, you’re talking at least $50,000 to get listed after lawyer fees, etc.

I’m hoping that regulators see the necessity in reforming processes for direct investment in small businesses. I have my fingers crossed, but I may die before they’re unwound.

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Sam August 17, 2011 at 10:31

It was 20 years ago that I had an opportunity to invest in a small local business. The company had a bad year and needed money for new equipment that would lower costs.

I never thought that my city could sustain a high-end furniture store. I thought that this loan would go bad. Banks declined this fellow left and right. 20 years later I know I was wrong. I should have lent the company my money. I should have purchased a piece of the equity too. I still think about what I missed.

If this local stock market takes off I will definitely make a few investments.

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JT McGee August 17, 2011 at 10:58

Furniture sounds like low margins and lots of competition. I would probably run away from it too, especially if the business owners wanted to borrow money after a bad year. Sounds like a double whammy.

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Sustainable PF August 17, 2011 at 10:47

If the financials and business plan are fundamentally sound then we would engage in locavesting. We have been exploring (eek!) opening a restaurant with a friend. Thing is 80% of new restaurants fail in 3 yrs or less (so i’ve been told). Also, investing with a friend can be problematic.

Either way, if we had a good opportunity I think we’d jump on it.

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JT McGee August 17, 2011 at 11:01

Eighty percent of new restaurants do go out of business in 3 years or less, but I think 80% of all businesses go out of business within 3 years or less. Restaurants are really difficult to scale, I think. “Restaurateurs” usually find that hiring a capable manager means paying so much that the risk isn’t worth the cost.

Restaurants scare me since they seem to turn into an owned job, which isn’t a business. That isn’t to say that some haven’t been disgustingly profitable.

Good to know you’re in for locavesting. I figured the SPFs of all people would be interested in it.

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Sustainable PF August 31, 2011 at 20:02

Of course we like the idea JT! Right up our alley. To support the community you live in is going to have a ripple effect which will positively influence so many lives.

Please be sure to check out or monthly link love to see where this article placed ….

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krantcents August 17, 2011 at 15:32

My only concern wold be if the business owner would totally honest with me. It is difficult to have partners/investors and maintain the integrity of the business.

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ImpulseSave August 17, 2011 at 15:37

My experience is the exact opposite. Having investors always calls us to a higher standard. We work later, longer and harder when we know someone else believes in us and frankly, is giving us the money to stay in business. I get the feeling that most small businesses are this way. In fact my gut would be that a small business owner would be more honest with your than a large corporation that can hide behind small print, but maybe I’m being naive.

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JT McGee August 18, 2011 at 11:40

I would say that small businesses are probably safer, too. Big 4 accounting firms aren’t going to be auditing the books–that much is certain–but small businesses usually use cash accounting systems which make it really, really, easy to track the relationship between EBITA, stated earnings, and cash flow.

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Doctor Stock August 17, 2011 at 21:23

I love the P2P investing idea… I’d certainly be open to investing in what I can visit, support, see, evaluated, etc. on a regular basis. I do that on a micro scale by visiting companies whose stock I purchase, like LULU or SBUX… while it may be a micro sample of enormous companies, the concept of acceptability and support is similar.

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JT McGee August 18, 2011 at 11:40

Yeah, definitely–I do that, too.

I can see that to be a very valuable part of the lending process.

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Darwin's Money August 18, 2011 at 07:20

Sure, local investing helps your real estate values, improves your school district with more tax revenues, etc. It’s definitely got its perks. These P2P outfits have to get their act together and get approved in all states though; Prosper was actually Disapproved in my state a while back and I had to stop lending…No Lendingclub either.

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JT McGee August 18, 2011 at 11:41

Good point on real estate values, school districts and other trickle down effects; I hadn’t even considered that.

And yes, you’re definitely right on the P2P noise. They need to get their ducks in a row, so to speak.

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Evan August 25, 2011 at 14:15

I don’t think this is as hard as you are making it out to be…

How about a Depositor Owned (mutual) credit union. If you want to lend out all you have to do is be a member with XYZ in savings – which is then used to lend to small local businesses. If the union has a good year it can pay a dividend to the member-owners.

I can’t believe I just came up with that in 30 seconds! Its not ownership but it is absolutely investing in local businesses

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JT McGee August 25, 2011 at 14:29

Hmm, but then you have the problem that:

1) You can’t pick and choose
2) Probably can’t form a CU without NCUA, which has risk and capital requirements because, above all else, a CU is a retail bank.

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Evan August 25, 2011 at 14:34

I get that it isn’t YOU choosing but rather some loan officer, but the NCUA and the requirements is a good thing…could protect a member-investor’s principal.

I am just not sure if the goal of a CU could be foster local businesses vs. having to offer retail products (Mtgs, auto loans, etc.)

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JT McGee August 25, 2011 at 17:59

What I’m saying is that the CU would have to provide retail products if only for the purposes of meeting the NCUA’s guidelines on portfolio risk, and federal law. Credit unions are required to keep their business loan portfolios at a value equal to less than 12.5% of their assets.

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Evan August 26, 2011 at 09:11

I am not sure it could work with 12.5% regulations, but I still believe there is an idea in here somewhere. Some sort of mutual company that people can invest in that would loan out money to small local businesses.

Cherleen @ The College Investor September 9, 2011 at 22:17

I go all the way for “locavestment”. I run a small business and I am willing to invest more on small businesses to help other people get jobs.

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