Small Business: high risk, high reward for the canny investor

The value of small businesses in our economy is often overlooked when planning an investment portfolio. But small businesses equate to a substantial impact in nearly all economies worldwide. There are more than 25 million small businesses in the US alone, accounting for up to 60% of jobs – and in a recent study by Paychex, small businesses have produced 13 times more patents than larger firms.It’s important for government and the economic environment to provide the right climate for entrepreneurs to flourish, not only through smart regulations and tax structures, but through access to capital and business advisors. For instance, investment firm Goldman Sachs is helping small businesses in the US by providing them with greater access to business education, financial capital, and mentoring. According to a Goldman Sachs spokesperson, “Small businesses play a vital role in creating jobs and growth in America’s economy.”

Opportunities in this potential growth market in all countries should therefore be investigated by the canny investor who is not too risk adverse.

In South Africa

Contributing to roughly 32% of GDP, Small and Medium Enterprises (SMEs) in South Africa have been identified as productive drivers of inclusive economic growth and development. They make up a large percentage of business and provide employment totalling over 50% of the labour force. Small businesses are seen as an important contributor to building the economy as the formal sector continues to shed jobs.

Small businesses are particularly useful in developing new sectors of the economy, contributing fresh perspectives, products and services. And it is vital for government to ensure positive frameworks to help develop and support small businesses. In this environment, it’s not always easy to pick the right venture because of crime, corruption, inadequate skilled labour, lack of management skills, and stifling regulations.

Nevertheless, venture capital can return good results provided you do your homework.

Venture Capital

There are 5 key aspects, investors need to evaluate before committing their investment backing to a small, perhaps even untried business:

Originality: How well does this company differentiate itself from what is already out there. And how strong is its brand? This would depend on just how unique the product or service is. If the company is up against many other profiles that are too similar, you will need to find that pertinent element that may distinguish it from others, the value proposal that customers prefer. Your evaluation of customer surveys, media data and the power of the brand will be important. Products can be copied, but brand image cannot.

Production costs: The difference between what a product costs to produce, and its final retail price is key. If there is a very narrow gross margin, it means there is no room for error, and any problems could take their toll. Look for the sectors that offer the highest gross margin such as: personal hygiene, pet food, natural and organic products.

Leadership: Very often a small business brand replicates the image of its owner-starter. You need someone you can trust in, believe in – and who has some reputation and track record of success and knowledge of his or her field. Do they have a passion for their business and tenacity to deal effectively with adversity?

Repeat customers: What is the shape of the customer base? Repeat customers are the core of a growing business. Their happy customers and evidence of recurring revenue is an important signal of the value of the business going forward. It shows that the product is popular and the business has the power to maintain standards, look after their customers, grow their base and build revenue.

Sale value of the business: Should there be a need for an exit strategy, the business should have built enough traction to attract a strategic buyer. This attraction should be viable and not imagined – and those with specific interest in the business and likely to want to acquire it, should be defined and evaluated ahead of the time for any such move.

Spreading your options in a changing the world

At Foster Wealth, we’re aware of a daily changing world. Technology is influencing the way we think, work, live – and the way we invest. Among small businesses and start-ups may lie gems worth investigation – which can, depending on strengths of possibility and practicality, pay dividends to the investor willing to take the risk.

While we know that innovation and young blood can be exhilarating, we would advise you to approach these investments with caution and sound assessment. The financial knowledge, experience and personal attention of a professional advisor are still key to making your decisions work effectively.

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