A 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:
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:
- Fixed costs – Lawyers cost the same amount to draw up $10 million financing agreements as they do to draw up $10,000 agreements.
- 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.
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:
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.