How to Invest in Local Startups and Small Businesses When You're Not an Accredited Investor

Hey guys, Matt Paulson here. In this video, I'm going to answer kind of a lengthy question that I got over Facebook from a high school friend and she's got a question about investing in local businesses when you are not accredited yet. So she said that our financial situation shifted slightly and we're looking to start investing in small ways, a few thousand dollars each, into interesting local ventures that align with our interest. I have two questions. First, are you personally involved with an investment group that is currently accepting low dollar participants? And second, more importantly, have you written or can you recommend an article about the best way to set up these investments in local businesses to maximize your financial gains and minimize taxes? I appreciate your guidance. Sorry for the clumsy question. I'm new to this. This is a good question and it's one that I've gotten several times. Let's say you've got a little bit of money to invest in local businesses, but you are quite at the level where you would be considered an accredited investor by the SEC guidelines. So maybe you're in a situation where you don't want to put money in real estate or the stock market. You think, hey, maybe there is a business down the street that I can invest in. That way I can leave money in my local community, help our local business owner, and hopefully make a good return in a process. So typically if you want to invest in local businesses or local startups, normally you would do that by joining an angel investment fund or maybe a private equity fund. But typically to do that you have to be able to prove that you make at least $200,000 a year as an individual, $300,000 as a married couple, or simply having a million dollars in assets outside of your home. So if you meet one of those qualifications, you are considered an accredited investor in the United States. The thought that they the SEC has is that if you meet those guidelines, you can afford to make some big mistakes with your investments. So if you lose all your money that you put into a single investment and you're an accredited investor, it's probably not going to ruin you financially. If you haven't reached accredited investor's money yet. The government just doesn't want you taking risks on high risk, high reward investments because you put all your money into someone else's business and it doesn't work out, you're probably bankrupt and then you're going to have to rely on the social safety net, food stamps and the like. Generally speaking, I think this is a pretty good rule. You should probably only mess with more interesting investments like local businesses and you know, not stuff that's more traditional like stocks, bonds and real estate. You know, once you're already, you know, you kind of do the private equity stuff, the angel investing stuff. After you do some of the basics, let's say you have a good amount of savings, you've maxed out your IRAs, you maxed out your 401k plan and you have a healthy income. At that point you're probably okay to make some higher risk, higher reward investments. But you really want to make sure you have the basics covered first. So get your debt paid off, start saving for retirement, have some cash in the bank. If you're there, you might already be accredited and then you can participate in an angel fund or do angel investments. But if you're not, maybe there's a place to do some investing in local businesses, but we'll talk about that. So if you are accredited, you can do the angel fund thing, you can invest in Bootstem, you can make Angel Investments through AngelList, there's lots of options there. But let's say you're doing well, but Maybe you're making $100,000 a year and aren't quite accredited yet. You're doing well, but not at the official SEC ACC accreditation level yet. The reality if that's you, where you're doing fine but not accredited yet, there just aren't a ton of good ways to invest in local businesses or startups kind of a few thousand dollars at a time, kind of at that stage. At that point you can't really join an angel investment fund or a private equity fund because you have to be credited to do those things generally kind of on a one off basis where you would invest a few thousand dollars at a time into a local business. It's just not enough for any business owners to get excited about to take on a partner. There are some websites that will let you invest in kind of venture startups or venture funded startups a few thousand dollars at a time, but I really don't recommend those. And the reason is that if a startup is raising money in one of those platforms, you probably couldn't get it from an actual angel investment fund or venture capitalist or more traditional venture capital fund. The companies on those websites where anybody can invest in a startup, there's a few of them, I don't really want to name the names, but they tend to be the leftover startups that don't get funded by more traditional vc. So I just kind of tell people, probably stay away from those. There are a Couple of things you can do, though. One thing you could do is set up an investment club with a few of your friends that are at a similar income level to you. And you could make stock and real estate investments together as a group. So you could research stocks, maybe you could buy rental property together. I did this with actually six other friends back in 2012. First, we would have meetings and we'd buy stocks with the money we brought to the fund. And we did that for a while and then we thought, oh, you know, this isn't that fun to any of us. Do this by ourselves. Why would we do it as a group? And at that point, we decided to buy a rental house, which we did. We still owned a rental house, and it was fun for a while. We had some challenges. My income is quite a bit higher than the other people the fund. So it's kind of become a problem where it's kind of a big deal for them, but no longer a big deal for me. But I think some of them still enjoy it. We've also all gotten kind of busy, so nobody wants to mess with the rental house just because something is. Be aware that if an investment club sounds like a good idea today, it might not be five or ten years from now as your life circumstances change. So just be aware of that. But there are plenty of people that have done investment clubs as friends, and it's worked out perfectly well. The other thing that you could do is find an existing local business that maybe you're excited about, maybe you know the owner, and maybe there's an opportunity to become a partner in that business. So maybe you've got $10,000 to invest. Maybe you could become an employee of that business part time or full time, and you could get a piece of ownership in that business as well. I think many business owners would be relieved to have a partner, to have somebody else that's an owner of the business that is really thinking about the business 247 like they are. To know that you're not alone as the owner worrying about the business all the time, that can be a relief. So there maybe are solo business owners out there that would love to have a partner. Just haven't found the right person to be a partner yet. Where you could come in and say, hey, I'll be a minority partner. I'll put some money in the business, I'll work it, I'll help grow it. And that happens all the time. I did that with my friends Jason and Stevie Shea. They were starting a fundraising software business that they had Some really good history and experience with. And I thought, hey, I think it could help with this. So I put in a little bit of money. It was maybe 10 or 15 grand, I can't remember the exact amount. And I got a third of the business and I helped out with marketing. So I figured out where to get distribution list for animal shelters and then we sent direct mail to those animal shelters advertising our product several years later. Continues to be a great business. Makes a few hundred thousand dollars a year in profit and it should become a nice little business that they run day to day. But I've invested in it and it makes profit for all of us. The second part of your question where you ask about setting up these investments and maybe a tax advantage way, there's just not a really great way to do that. Typically if you're the owner of a local business, you either hold that in your name or maybe the name of a trust if you really want to get complicated. But you can do things like what's called a self directed ira where you can put money into private equity investments or which, you know, an investment in a local business or local startup, that would be a private equity investment. But it's typically not a good idea to do that because you should really only be investing in local businesses or local startups kind of after you've maxed out your IRA or your 401k plan. These investments tend to be very high risk and high reward. Chances are you're going to lose all your money in half these deals that you do. So you really want to make sure you have the basis covered on your IRA before you mess with one of these things. So typically with angel investment stuff, I typically hold it in my own name. There's not a good reason to do it anyway. And if there are any returns, they're going to be long term capital gains anyway. So that way for me, there'll be a 20% tax rate instead of my normal 37% tax rate. So the capital gains that you might have on one of these investments are already tax advantage. So it's just really not worth getting super complicated trying to avoid taxes on these things. So hopefully this answers your question. Sorry, I don't have a quick and easy answer for you. Unfortunately, investing in local businesses, small businesses or startups, it's just kind of a complicated endeavor. There's a very high risk of failing. It's not for the faint of heart. And you really have to find somebody that you can work with as maybe a minority owner or investor in a business. Long term. But there are a couple of options to consider. One, that investment club that I mentioned, or two, just finding a local business that maybe you could become the minority owner of. You could pursue that as well. I think that's it for this video. Thank you for watching.