Investment Opportunities in Small Businesses?
John Kay’s interesting commentary continues with a recent FT article going into detail on the way banking has shifted from supporting other businesses to supporting itself. Put together with his earlier commentary on the 90s asset bubble where investment markets were twisted to reward entrepreneurs before they did the hard work (just as bank executives are sometimes rewarded for not doing their job now), this paints an interesting picture.
As he claims, large companies generate a lot of cash already to cover their spending and get more from the stock and bond markets without having resort to ordinary bank loans. In other words they would mostly be serviced by investment banks. Smaller businesses (which generate a lot of economic activity because they have more growth potential) can’t raise capital that way so they rely on bank loans, but those loans have dried up in the last few years. Presumably this means that ordinary bank deposits are used more for proprietary trading and the like rather than business loans.
This has interesting results on two levels. As a large-scale policy, it makes sense that we would want to have more lending to the small businesses that generate a lot of economic activity and are being dragged down now. A government response aimed at this might have the impact we need right now in North America.
But this could also have an effect on the individual investor. If small businesses are being held back mostly by a lack of capital because no one is looking at them, private investors might be able to step in and fill the void. In turn they should earn a good return for taking this risk and providing this valuable service. The investors get additional returns, the businesses get the capital to expand, and the the economy turns up a bit.
It might seem that this would be risky because you can’t save the whole economy just by lending to one business. There are some businesses that will only survive if the economy does well, but there are others that can make good returns in the current environment. And if their increasing success and the resulting spending and investment helps support other businesses, it just might start a growth feedback cycle and increase their success.
This opportunity is a bit limited because the average person doesn’t have the knowledge and skills to evaluate the future prospects for a small business, or much capital to risk in a loan to it. It would take some diversification because you can’t bet everything on one business. But for those who have a suitable level of capital and experience (such as a few million earned from their own business) there could be a lot of attractive loans to make. And it’s worth keeping in mind in case any opportunities to get involved in a small way come up.
Not all small businesses deserve more credit – the majority might just be too risky – but it seems that some do need more and would reward investors who have the foresight to get involved. In fact if there’s enough opportunity here it might make sense for investors to create an organization that would gather capital in small amounts, review businesses that need loans to determine their creditworthiness, administer the loans, and spread out the risk. You could call it a Business Association for New Credit.