Overview of Local Investing

Overview of Local Investing

As a community organizer that’s promoting local investing, you need to have a basic understanding of the nuts and bolts of the field. Local investing opportunities come in many forms, with varying degrees of complexity and risk. Broadly speaking, there are two main categories: securities, which are legally regulated and generally more complex, risky, and appropriate for experienced investors, and non-securities, which are generally more simple and appropriate for novice investors. As a result, non-securities can be easier to promote and introduce to a community that’s not familiar with local investing yet. Although non-securities are not traditionally considered investments, they do enable investors to create a positive local impact with their money while receiving benefits in return. Here is a brief list of local investments that are not securities, and are therefore most appropriate for those just getting started with local investing to consider:

  1. Deposits at local banks & credit unions; these institutions can lend money back out to local small businesses and nonprofits, but you should inquire about their commitment to do so.  BankLocal is a great website that can help you identify which banks nearby reinvest in your community the most.
  2. Donation-and reward-based crowdfunding, through websites such as Kickstarter and Indiegogo, where investors can help fund both local and non-local businesses, nonprofits, and other projects, and investors can receive non-financial rewards, such as products or services, in return.
  3. Pre-sales whereby local investors/consumers pay for products or services up front, often at a small discount to retail value, in order to provide startup, expansion, or operating funds to local small businesses, which fulfill their commitment to their investors over time.  Community Supported Agriculture (CSA) is a great example of this, as farmers are paid for their work before the season, when their expenses are the highest, and deliver their harvest weekly throughout the season. CSAs are great way to support local farm businesses, and are available in most regions.  Credibles is a website that facilitates pre-sales for growing food businesses so that they can expand their operations to meet demand.  Sometimes, creative local businesses such as restaurants or breweries will run their own presales campaigns to fund their growth. Securities, on the other hand, are essentially any kind of agreement in which an investor gives money to someone else with the expectation of receiving repayment plus a profit in return. 

    Securities include ownership stakes (shares, or equity) in a business, loans to a business (also called promissory notes, or debt), revenue-sharing agreements, and virtually any other kind of investment contract – even personal loans made between friends and family at any interest rate greater than zero (because zero percent loans are not securities; see above).  Since the eventual return of the investors’ principal (the money they put in) plus any profit depends on the management and business skills of the borrower or investee, there are inherent risks in securities, which is why they are carefully regulated by governments and are generally more appropriate for investors (and their advisors) that are ready to do the work to evaluate those risks and decide if they are appropriate to take.

    In addition to the type of security (equity, debt, etc.), local investment securities also vary significantly in how and to whom they are offered, advertised, and sold:

  4. Peer-to-peer lending at a zero interest rate, either through websites such as Kiva Zip and Community Sourced Capital, or directly to local people and/or businesses.
  5. Private Offerings of securities are generally not advertised, not as heavily regulated by governments, and arranged directly between the parties.  Generally, the investment sponsors may only offer their investing opportunity to people they have a pre-existing relationship with, which is why building direct personal relationships and networks is so vital in local investing.  The vast majority of local investing securities fall in this category, so the courses on this site provide guidance for both investors and businesses that want to facilitate these kinds of direct investments.  They can be offered by the whole spectrum of local businesses, such as retail stores, small manufacturers, farms, construction businesses, and professional service providers; and nonprofits, such as private schools, radio stations, employment agencies for disabled people, and land trusts and other conservation organizations.  Local Investing Clubs & Networks and Organizing Business Showcases are the best ways to connect the people that can offer and fund these local investing opportunities.
  6. Direct Public Offerings (DPOs) are like local IPOs (Initial Public Offerings) that enable small businesses and nonprofits to run public campaigns to raise money from large numbers of people.  DPOs must be reviewed and approved by securities regulators in one or more states before advertising and sales to eligible investors can begin.  They are relatively rare because of the commitment of time, energy, and money an organization must make to receive regulatory approval and run a successful campaign, but they are growing in popularity because they allow relatively large public outreach campaigns that would not be possible otherwise.  You can find out about nearby DPOs through your local networks and online listing services like CuttingEdgeX.
  7. Investment Crowdfunding is a new and mostly untested type of offering that is based on the online Donation-and Reward-based Crowdfunding model, except that the issuer may offer securities to investors, with the possibility of eventual profits, instead of just product or service rewards. As of late 2014, investment crowdfunding is legal in a few states, and is likely to expand to more states and the federal level in the coming years.

A Word about Risk

Local investments almost always depend on the ability of the people backing them (typically 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, which in turn should enable the investment to succeed.  Therefore, the risks in local investing are about as varied as the people that want to raise money from investors.  For example, local investors may encounter experienced local business people that have established, long-running, profitable businesses and solid reputations in the community that want to refinance a high interest bank loan at lower rates, using their existing cash flow – a good example of a fairly low risk local investment.  Local investors may also encounter any number of people 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, they should recognize how little is known about the possibility of actual success, and therefore how high the risk of this investment may be.  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 section on Evaluating Local Investments.

As a community organizer who wants to catalyze local investing, the success of your efforts depends to a good extent on the outcomes of the local investments that happen in your community.  If word gets around of high profile investment failures like bankruptcies or fraud, local investing can get a bad reputation in the community, and it can affect your reputation as well.  While most investors understand that financial losses are an inevitable aspect of investing, and are guaranteed to happen sooner or later, it’s in your best interest to do what you can to facilitate positive investment outcomes.  The best way to do this is to educate both businesses and investors by connecting them with the resources they need to succeed.  For example, business people need to know how to run solid businesses, develop good business plans, and go about raising money from investors legally.  You can connect them with local SBDCs, business consultants, entrepreneurship or accounting classes..  Investors need a basic education on local investing concepts, especially how to research and evaluate local investments and make good investing decisions for themselves; you can refer them to our How to Invest Locally section.  This way, you can help create an environment that is built for long-term success.

A Word 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.  Generally speaking, it is incumbent upon businesses that choose to offer securities to comply with securities laws and regulations.  Most small business owners and managers know little to nothing about securities laws and regulations, and therefore need education and support (and when needed, legal advice) to avoid running afoul of them.  It’s a good idea to seek out local attorneys who are knowledgeable about securities law to be part of your local economy ecosystem, although they can be hard to find, especially in smaller communities.

 
Accredited Investor Definition:
 
Net worth of over $1 million (not including primary residence)
 
– OR –
 
Individual income over $200k or joint income over $300k in each of the last two years.
 

Accredited investor is a legal term that all local investing catalysts should know because it comes up quite often around securities offerings.  In short, accredited investors are people with enough assets or income that lawmakers feel less need to protect them from risky investments.  The legal definition, as it applies to individuals, is someone with an individual or joint net worth of over $1 million, not including the value of their primary residence, or an individual income exceeding $200,000 or a joint income exceeding $300,000 in each of the two most recent years, and a reasonable expectation of exceeding the same income level this year.  Federal and state securities laws and regulations allow companies to offer securities to accredited investors under less stringent regulatory requirements than are normally imposed on companies.  Accredited-only investments are relatively rare in the local investing world, because most local small businesses feel they need to be able to raise money from all types of investors, not just wealthy ones.

When making private offerings to nonaccredited investors, which are the most common types of local investing opportunities, local small businesses generally cannot advertise their opportunities, speak publicly about them, or even speak privately about them with people they do not have a pre-existing relationship with.  In public, and in private with people they do not already know, business people can discuss almost anything—their personal and business history, their business’ mission and values, the opportunities and challenges they face, and any other non-financial matters—but not investment-related information, including terms, amounts, financial projections, and details of previous investments they have offered.  Creating the frameworks that help both investors and entrepreneurs navigate these subtle boundaries is a key role of local investing groups and community organizers aiming to catalyze local investing.  Local business people should be encouraged to network extensively, meet people that are interested in supporting their business, and build relationships with them over time.  Then, in private, with people they have already built pre-existing relationships with, they can engage in investment-related discussions and negotiations.  These legal restrictions are another reason why local investing activity thrives on relationships and networking, which is what your local economy ecosystem is intended to promote.