Is it Safe?
In general, you should avoid investing any money that you cannot afford to lose. If you have outstanding credit card balances or other debt (except for a home mortgage), consider investing in yourself first by paying down debts before investing in others locally.
The potential for success of local investments depends greatly on the ability of the owners, management, staff, directors, and/or advisors of a business to execute their business plan, deal with the unexpected, and ultimately achieve their goals. Therefore, the risks in local investing are about as varied as the people trying raise money from investors.
Experienced local business owner with long-running, profitable business and solid reputation in the community. Wants to refinance a high interest bank loan at a lower rate, and will use existing cash flow to repay debt. >> Fairly low risk investment
Young, energetic, first-time entrepreneur with dreams of starting a business to provide a product or service that they are sure will be in high demand. Even if the investor agrees and buys into the dream, little is known about the possibility of actual success. >> High risk investment
Whether low risk, high risk, or somewhere in between, all investment opportunities require due diligence. Due diligence is the process of evaluating the risks in a given investment, comparing them to the risks that the investor knows they are willing and able to accept, and making a decision about whether or not to invest.
We explore due diligence in much greater depth in our guide to Evaluating Local Investments.
What about Legal Issues?
The purpose of securities laws and regulations are very clear: they exist to protect investors. They are intended to prevent fraud by investment issuers and to level the playing field by requiring disclosure of material facts and risks to potential investors. Although these laws and regulations can be hard to understand, and investors are not primarily responsible for complying with them, it can be empowering to have a basic understanding of them. Investors can avoid potentially troublesome investments and legal issues by recognizing when the issuer of a given investment is complying with the law or ignoring it, either intentionally or unknowingly.
For local investors in the U.S., here is a very brief overview of what you should know. Laws are passed by legislative bodies, such as Congress, and are generally intended to set broad policies. Rules and regulations are written by government agencies for the purpose of filling in the regulatory details needed to comply with and enforce the laws. Both laws and regulations have full legal effect. Securities laws and regulations exist on two levels: federal and state. The Securities & Exchange Commission (SEC) creates federal regulations authorized by laws that Congress passes, and it also enforces those laws and regulations. Every state also has its own securities regulator (sometimes contained within a larger department or subdivision of state government) which writes regulations based on laws passed by the state legislatures, and it enforces those laws and regulations. As a result of this system, there are always at least four legal areas pertaining to any given investment offering: federal and state securities laws, and federal and state securities regulations. They all collectively dictate the “rules of the road” for all securities offerings you will encounter.
Accredited Investor Definition:Net worth over $1 million (not including primary residence) and/or Individual income over $200k or Joint income over $300k in each of the last two years and reasonable expectation of the same income level in current year.
An Accredited investor is a legal term that all investors should know, whether it applies to them or not, because it comes up quite often around securities offerings. Accredited investors are people with enough assets or income that lawmakers feel less need to protect them from risky investments.
Federal and state securities laws and regulations allow companies to offer securities to accredited investors under less stringent regulatory requirements than are normally imposed if unaccredited investors were to be involved. Therefore, businesses that believe they can meet their funding goals by working with accredited investors exclusively will often take advantage of those types of less regulated (and therefore less expensive) securities offerings.
The very real — and many people feel — unfair consequence of accredited-type offerings is that only a limited number of wealthy people have access to investments that include the most risky yet also most profitable opportunities such as private equity funds, venture capital funds, and hedge funds. Everyone else is locked out of these opportunities.
The regulatory changes enacted in May 2016 by the SEC in Title III of the JOBS Act have significantly broadened local investment opportunities for all Americans, regardless of wealth status. This presents the chance to create true economic justice for all by democratizing the local investing world. For this reason, and because there are extensive resources available elsewhere that support accredited investors and businesses that want to offer accredited-type investments, the Local Investing Resource Center primarily focuses on securities offerings available to unaccredited investors.
One final word about legal documents: When investing in local securities, a legal agreement will be needed to spell out all the terms of the investment between you and the investee. For DPOs and accredited-only private offerings, it’s likely that the agreement will be written beforehand and presented to you for your review and signature. For other private offerings, the agreement will often need to be negotiated and written by one or both parties. If you are just getting started with local investing, or uncomfortable with legal agreements, you should consult an attorney before negotiating or signing any investment agreements. However, many local investors, over time, develop a level of comfort with negotiating simple investment contracts such as promissory notes. Basic template documents are available for free online, and it’s a simple matter to edit the document’s terms to match what has been negotiated. Take the “Do-It-Yourself” approach at your own risk, but know that many experienced local investors do this, especially for smaller and more straightforward local investments.