Engaging

Direct local investing is slow yet rewarding. Local investors need passion, time, and energy to find and evaluate opportunities and get to know the people offering them. Get-rich-quick results are rare and not the expectation of local investments.

As private investments (not traded on public exchanges like the New York Stock Exchange or NASDAQ), local investments are illiquid, meaning they cannot be readily sold for cash without significant value loss. Direct local investing requires a “buy and hold” mindset. Returns may be well-defined (loans) or uncertain (stock shares). Understanding different security types, their risks, and liquidity is essential for due diligence.

Ways to Invest Locally

Local investing opportunities come in many forms, with varying degrees of complexity and risk. Broadly speaking, there are two main categories:

Securities

This broad category includes debt and equity investments where investors expect repayment plus returns. Common types include stock, LLC membership units, limited partnership interests, bonds, investment notes, convertible notes, revenue share instruments, and digital tokens.

A security is any agreement where an investor gives money expecting repayment with a financial return. Even personal loans between friends at interest rates above zero are considered securities. Since principal repayment and profits depend on business management, securities carry inherent risks and are carefully regulated.

Common types:

Equity: ownership stake in a business
Debt: some debt instruments offered broadly (not all debt is securities)
Royalty: revenue or profit sharing agreements

Non-Securities

Some investments aren’t regulated under securities laws but may fall under other regulations. These include gifts and grants, bank deposits, direct real estate ownership, and some debt types (private loans for personal use or secured by real estate).

Non-securities opportunities include:

Bank/Credit Union Deposits: Institutions lend your money to local businesses and nonprofits. BankLocal helps identify which banks reinvest most in your community.
Donation/Reward-Based Crowdfunding: Platforms like Kickstarter and Indiegogo let contributors fund projects for non-financial rewards like products or services. Well-suited for very early-stage ideas.
Privately Negotiated Loans: One-on-one negotiations, particularly real estate-secured loans, are typically not securities.

Legal Framework for Locally Investing

Securities laws and regulations protect investors by preventing fraud through the required disclosure of material facts and risks. While complex, a basic understanding empowers investors to recognize when issuers comply with or ignore the law.

In the U.S., Congress passes laws setting broad policies, while government agencies write detailed regulations. Both have full legal effect. Securities regulation exists at the federal (SEC) and state levels, creating four legal areas for any investment: federal and state securities laws, plus federal and state securities regulations. They all collectively dictate the “rules of the road” for all securities offerings you will encounter.

Accredited Investor
An accredited investor is someone with a net worth over $1 million (excluding primary residence) and/or individual income over $200k or joint income over $300k in each of the last two years, with a reasonable expectation of the same income level.

Accredited investors have enough assets/income that lawmakers feel less obligated to protect them from risky investments. Federal and state laws allow companies to offer securities to accredited investors under less strict requirements than for unaccredited investors.

This creates an unfair consequence: accredited-type offerings become the riskier yet more profitable opportunities (private equity, venture capital, hedge funds), while unaccredited investors—the vast majority of Americans—are excluded.

However, May 2016 SEC regulatory changes in Title III of the JOBS Act significantly broadened local investment opportunities for all Americans, regardless of accreditation status. NC3 sees this as an opportunity to create true economic justice for all by democratizing the local investing world. For this reason, and because there are extensive resources elsewhere for accredited investors and businesses that want to offer accredited-type investments, the resources we provide primarily focus on unaccredited, or what we call, local investors.

Due Diligence

Due diligence is the research process for choosing where to invest your money. While exciting, performing thorough due diligence is your responsibility and what differentiates a successful investment from an unsuccessful one. Due diligence research may include the following:

Concept & Industry

Start by exploring the business concept. Understand what it does, who it serves, and what needs it meets. How does it create value and profit? Is it new and unproven, or existing with a track record? What contributions does it make to your community?

Next, examine the industry. Do you understand this industry? Is it growing or stagnating? Is it seasonal?

If questions raise red flags or uncertainty, research the concept and industry more broadly. Are there others in your community pursuing this concept? Are there industry areas with more growth potential? Follow these leads to explore other investment opportunities.

Management

Many believe management is the most important investment factor as they execute the business plan, make decisions, handle the unexpected, and are accountable for the investment. Who is on the management team? Who selects them? Owners or the Board of Directors usually choose management and can replace them.

Identify advisors, consultants, or other influential people. Are there missing advisors who could improve the team? Due diligence provides an opportunity to give input to potential investees.

Research the management team’s background and track record. Do they have prior experience related to the business plan? Can you verify their experiences and character through references, credit history, or Internet searches? Does their track record inspire confidence?

Evaluate if they have all the needed skill sets: sales/marketing, retailing, operations/logistics, finance, and general management. Are key skills missing?

Consider management risks. Is the team diversified or dependent on one primary leader? If an indispensable older leader exists, is there a succession plan? Does the company have “key man” life insurance? What if the key person becomes disabled?

Remember that local investing’s distinguishing factor is building real relationships. Use due diligence to begin or strengthen relationships with those you’re investing in.

Financials

Assessing financials doesn’t require being an accountant, but you need basic comfort with numbers. If uncomfortable, get help for this part.

Analyzing Financial Statements
Familiarize yourself with statement items. Can you tell how much cash, debt, and recent profit the business has? Numbers gain meaning when compared through financial ratios. For example, the debt-equity ratio (total liabilities ÷ total equity) indicates leverage and associated risk.

Most ratios don’t have absolute healthy levels. Use them to understand how business aspects compare with each other and identify strengths/weaknesses for further inquiry.

What Financial Statements to Review
Financial information comes in two forms: historic (past results) and projected (future assumptions). Startups may lack historic numbers, but existing businesses will have them. Review all available information.

Historic financial information:

Income statements showing revenue and expenses over time
Balance sheets showing assets, liabilities, and equity at specific points
Cash flow statements showing how cash moves in and out over time

Tax returns provide additional historical information. At a minimum, obtain recent balance sheets and the last few years’ income statements. Well-managed businesses should promptly provide accurate, up-to-date statements. Consider delays a warning sign.

Financial projections are presented as future income statements and balance sheets. The best projections use models forecasting factors like widget production, pricing, and expenses to create future income statements.

Review projections against historic statements. Ask management about significant items like large one-time expenses or changes in ongoing expenses. Answers reveal how well they’ve thought out their business plan and values.

Assumptions
When examining projections, uncover underlying assumptions. Do they make sense? Many companies show rising revenues optimistically. Question what drives projected sales growth—sufficient marketing expenses should support rising sales.

For startups: When do sales begin? Is the timeline reasonable? Will the company have enough cash until then, plus extra for unexpected expenses or delayed sales?

Uncertainty
Projections are inherently uncertain. Established businesses can use current sales and growth rates for reasonably accurate projections, while startups typically make educated guesses. Ask management how they developed projections to gauge their certainty level.

Assess if projections are conservative or optimistic. Overly optimistic projections create a greater likelihood of worse-than-expected results. Evaluate the impact if sales miss expectations or expenses exceed projections. Will there be enough money to pay investors interest, dividends, or principal? If not, what’s Plan B?

The worst-case scenario must be something you can live with, given your investment amount. Due diligence helps determine the optimal investment amount as you understand risks better.

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Deal Structure

What are the investment terms? Terms should be recorded in legal documents:

DPOs: prospectus
Large private offerings: Private Placement Memorandum (PPM)
Local private offerings: negotiated agreements written by attorneys or parties
Equity offerings: also requires reviewing the Operating Agreement

While attorney review is recommended, many local investors write their own agreements for smaller, straightforward deals. Risks include omitting important terms, confusing language, or conflicting with laws.

Essential Terms
The structure of a deal can, and generally should, include the following terms. Be sure that all relevant details are addressed in the agreement.

Who are the parties? (For loans, consider cosigners for repayment security)
How much is being invested, and when?
How will the investment be used? Any limitations?
What type of investment? (loan, equity, revenue shares)
What updates will investors receive (financial statements, written reports, or meetings in person), and how often?
What payments will be received in return, and when? Will they be in cash, goods and services, or both?

Additional Questions by Investment Type

For loans:

What is the interest rate and does it change over time?
How often does compounding occur?
When do payments begin? (Sometimes, small businesses can benefit from not having to make payments for an initial period after the investment is made, so they can focus on building their business. During that period, interest will accrue, but the investor will be paid afterwards.)
What constitutes default? (failure to make payments on time, or at all.)
What are the consequences of default? This is very important, as it gives the borrower an additional incentive (beyond wanting to keep their word) to stay on track with payments. Can the borrower “cure” the default by getting back on track with payments, and if so, how?
Is the loan backed by collateral?

For equity:

How much will be paid out in dividends, and when?
How many shares are being purchased, what percentage of the company does that represent, and how is the whole company being valued?
What voting powers does the investor receive?
Are there restrictions on transferring or selling your shares? (Usually, there are.)

For revenue shares:

How is “revenue” defined?
How are the revenue share payments calculated? Do they have a cumulative cap or time limit?

Big Picture Considerations

What’s the total amount of money being raised from all investors?
What if only partial funds are raised? Do early investors get their money back?
How much debt and equity will be in the company after the deal is done?
What is your expected annual return after all factors?
Is risk aligned with expected returns?
Are other investors receiving different returns?

Final Analysis

You’ve evaluated concept, industry, management, financials, and deal structure. If still interested, step back for the whole picture.

Consider scenarios you haven’t evaluated yet. What are the most likely outcomes? Are you comfortable accepting all identified risks?

Revisit your investing goals and values. Is this investment a good fit? Will you have enough liquidity afterward? How much of your local investing allocation does this fill? Will you optimize tax consequences through a Self-Directed IRA? Does it align with your values?

Have you developed a trusted relationship and good communication with management? Do you expect this to continue during the investment term?

If working with a team, what do others think? What do professional advisors say? If investing against advisor advice, have you addressed all their concerns?

What does your intuition say? Imagine signing the agreement and handing over the check—do you feel great? Are you being overly optimistic or following group opinion instead of your own?

At this point, you should be able to decide. If proceeding, arrange to sign the legal agreement and transfer your money. Welcome to local investing!

Finding Investment Opportunities

Local investments are built upon relationships and there are several ways to initiate local investing relationships.

Connectors

One common way to find investment opportunities is knowing a local “connector” who leads investing networks and introduces investors to business people. Like matchmakers, connectors arrange meetings to introduce parties and facilitate relationship building and investment discussions.

Business Showcases

Gatherings showcasing local businesses and nonprofits wanting community connections and potential investment. These are similar to community outreach events but focused on supporting local small business owners and nonprofit directors. Often public, though investment groups sometimes host private ones.

The crucial elements of finding a local investment opportunity are that the type of security is available to you, you can do a full Due Diligence analysis of the opportunity, it aligns with your values, and you have a relationship with the offerer.

Local Investing with Retirement Accounts

As of 2023, $37.8 trillion of American retirement savings were invested in the stock market (Congressional Research Service, 2023).

Employer-offered qualified retirement plans (401(k)s, 403(b)s, SEP IRAs, SIMPLE IRAs) don’t allow direct investment in private securities. Similarly, traditional and Roth IRAs cannot make direct private investments. However, growing interest in local impact investing drives a trend toward Self-Directed IRAs and Solo 401(k)s (for self-employed people) that allow tax-deferred retirement funds in local investments.

An excellent resource on creating SDIRAs and Solo 401(k)s is “Put Your Money Where Your Life Is” by Michael Shuman, an NC3 original founder. This Slow Money Northern California blog post also provides useful insights and tips.

Next - Sustaining

Feeling confident in engaging in local investing? Understand how to sustain the practice for long-term success and growth.