Small business investments are often structured as either a limited liability company or a limited partnership, with the former being the most popular structure due to the fact it combines many of the best attributes of corporations and partnerships. In years past, sole proprietorships or general partnerships were more popular, even though they provide no protection for the owners' personal assets outside of the company. For small business, there are two popular types of investment.
Equity Investments
An equity investment is an investment by individuals or firms. The investment is usually in the form of stocks whereby profits are in the form of capital gains or dividends. The investor considers equity investment as a long-term strategy of maximizing his wealth.
An equity investment in a small business can result in the biggest gains, but it comes hand-in-hand with the most risk. If expenses run higher than sales, the losses get assigned to you. A bad quarter, or year, and you might see the company fail or even go bankrupt. However, if things go well, your returns can be enormous.
Equity investors provide capital, almost always in the form of cash, in exchange for a percentage of the profits and losses. The business can use this cash for a variety of things, including funding capital expenditures to expand, running daily operations, reducing debt, buying out other owners, building liquidity, or hiring new employees.
Debt Investments
A debt investment is an investment in a firm through the purchase of a debt instrument as opposed to conventional equity investment in companies through buying common or preferred stock. Debt investments also include situations in which private investors finance debt products more commonly offered by banks or lenders.
When you make a debt investment in a small business, you loan it money in exchange for the promise of interest income and eventual repayment of the principal. Debt capital is most often provided either in the form of direct loans with regular amortization or the purchase of bonds issued by the business, which provide semi-annual interest payments mailed to the bondholder. The biggest advantage of debt is that it has a privileged place in the capitalization structure.
That means if the company goes bust, the debt has priority over the stockholders (the equity investors). Generally speaking, the highest level of debt is a first mortgage secured bond that has a lien on a specific piece of valuable property or an asset, such as a brand name.
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