Small-business returns

If you have the drive and
determination, you can start your own small business. Or perhaps you have
what it takes to buy an existing small business. If you obtain the necessary
capital and skills to assess opportunities and risk, you can invest in someone
else’s small business.
What potential returns can you get from small business? Small-business
owners like me who do something they really enjoy will tell you that the
nonfinancial returns can be major! But the financial rewards can be attractive
as well.

Every year, Forbes magazine publishes a list of the world’s wealthiest individuals. Perusing this list shows that most of these people built their wealth

by taking a significant ownership stake and starting a small business that

became large. These individuals achieved extraordinarily high returns (often

in excess of hundreds of percent per year) on the amounts they invested to

get their companies off the ground.

You may also achieve potentially high returns from buying and improving an

existing small business. As I discuss in Part IV, such small-business investment returns may be a good deal lower than the returns you may gain from

starting a business from scratch.

Unlike the stock market, where plenty of historic rate-of-return data exists,

data on the success, or lack thereof, that investors have had with investing

in small private companies is harder to come by. Smart venture capitalist

firms operate a fun and lucrative business: They identify and invest money in

smaller start-up companies that they hope will grow rapidly and eventually

go public. Venture capitalists allow outsiders to invest with them via limited

partnerships. To gain entry, you generally need $1 million to invest. (I never

said this was an equal-opportunity investment club!)

Venture capitalists, also known as general partners, typically skim off 20 percent of the profits and also charge limited partnership investors a hefty 2 to

3 percent annual fee on the amount that they’ve invested. The return that’s

left over for the limited partnership investors isn’t stupendous. According to

Venture Economics, venture funds have averaged comparable annual returns

to what stock market investors have earned on average over this same

period. The general partners that run venture capital funds make more than

the limited partners do.

You can attempt to do what the general partners do in venture capital

firms and invest directly in small, private companies. But you’re likely to be

investing in much smaller and simpler companies. Earning venture capitalist

returns isn’t easy to do. If you think that you’re up to the challenge.