Regulations regarding investing in a private business

Question

There have been a couple of years where, after maxing out contributions to retirement accounts, I've had some disposable money left over that I'd like to invest in something other than publicly traded funds.

I live in a community with lots of youngish small business owners of various types, food trucks, restaurants, retail, fabrication etc... Many of these people that I've spoken with lack growth capital, and I've often wondered if it would be possible to invest in businesses in these situations, as a sort of mini-angel investor.

I've done a fair amount of research and feel like the following scenarios would qualify under a friends and family round 504 exemption:

1. I invest X-thousand in a local food truck whose owner I'm acquainted with. I do this in exchange for Y% of revenue until Z ROI is achieved.
2. I lend X-thousand to a local fabrication lab to allow them upgrade their equipment at an interest rate of Y% until the loan is repaid.

Assuming I've done my due diligence regarding these businesses and their owners, and have this cash available, are there legal hurdles that I'm not aware of to this type of investing? Would the business owners have to file with state or federal regulators in these situations?

I'm specifically talking about USA - Idaho, but any general advice for anywhere in the US is also appreciated.

Update

The question isn't about financial risk, just about legal risk. I'm aware of the financial risks in this type of investment. I'm specifically looking for authoritative resources, not just opinions.

More specifically, I'm aware of three ways to approach this:

1. Silent Partner (which I'm not interested in, due to liability issues).
2. Act as a lender, no regulator hurdles that I'm aware of, but you're restricted to specific interest terms of a promissory note, whereas I'm more interested in equity and or profit/sharing.
3. Friends and Family round investing, which is what I know the least about.

I'm interested in information regarding option 3, or additional options that I'm unaware of.

Answer 1

The laws surrounding private investment, specifically securities laws, don't restrict your ability to invest as much as they restrict a company from marketing to you for fund raising. There are laws that restrict the volume of money you are legally allowed to invest in such a public/semi-public investment in a privately held company but that's really not the issue here.

Investing in such a small business is exponentially more risky than buying publicly traded securities. It is terribly risky to be a silent, non-operating, outside investor in a very small single employee owner-operator business.

When you buy Apple stock, you are buying someone else's shares. When you invest $10,000 in to a food truck, the company buys stuff. Your investment turns in to ingredients or a new paint job for the truck, or it pays credit card debt the owner already accrued in starting the business.

Small businesses tend to keep terrible books, and generally aren't formed in a manner conducive to accepting outside equity investment. If you do anything you'd want to lend the business money, mostly because that gives you the standing to sue the business. There are, however, lending laws which may limit the interest rate you're able to charge. Barring those limits, you could not possibly charge enough interest to properly reflect the risk you are taking anyway. 10% isn't going to do it.

Even in the VC/PE world investments tend to be some sort of convertible not a simple $X for Y% equity, or a loan for Z% APR. The venture capitalists want to participate in value increases but also want to be able to sue the company in a failure.

The flip side of the coin is the view from the business owner. If I have a profitable business, why on earth would I trade part of my business for your money? If my business makes me $200,000 net of expenses annually, how much would I take for 10% of that, 5x? Are you, investor, willing to pay $100,000 for 10% of a $200,000 EBIDTA business? If I have an unprofitable or struggling business, of course I want your money.

Then there are issues of your liability. If you want to pursue any of this you should probably form up your own LastAirbender Capital, LLC because you are going to have basically zero sight in to what the company(ies) you're investing in are doing. Maybe they haven't paid taxes, maybe there are already loans, maybe someone else is already suing them, maybe someone gets food poisoning, whatever; you are going to want your own shield. Just think about how much insight you have in to your best friend's finances.

Sure, I'm sure there are local businesses that could use a boost. You just need to appreciate that when you buy public company stock maybe it loses some value this year, your $10,000 is now worth $9,000. When you invest $10,000 in to a food truck there is no $9,000, there is no 10% loss. Your $10,000 is gone. There is no market to sell your exposure to this company.

It's not about return on your money, it's about return of your money.