Startups and young businesses often need extra funding to grow and expand, but their limited history makes it difficult for them to be able to get traditional business loans and the business owner might not want to risk losing major personal assets like their home to fund their business.
Equity financing is a way for businesses to get the funding they need without dealing with strict requirements at the bank or having to go into debt for a business expansion loan. Unlike many other types of business financing, equity financing is actually best suited for startups and young businesses.
What Is Equity Financing?
Equity financing is different from other types of business financing in the sense that you don’t go into debt and there’s nothing for you, the business owner, to repay. Instead, you raise money for your business by selling shares of your business to investors, who then become part owners in your business.
The percentage of ownership an investor has is proportionately tied to the size of their investment.
Pros and Cons of Equity Financing
If a person who has experience in your industry agrees to invest in your business, they may be able to provide very valuable advice and guidance that could help your business grow.
By raising money through equity financing, you’re able to shift some of the risk away from yourself. When a person agrees to become a partner in your business, they assume the risk that they might never get their money back. It allows you to get the funding without going into debt.
Just because equity financing doesn’t involve dealing with complicated loan applications, that doesn’t mean equity financing is fast or easy to get. You will need to spend a great deal of time developing a strong business plan to present to potential investors. In fact, seeking out investors, preparing your presentation, and pitching your business could potentially be even more time consuming than taking out a regular business loan would be.
Remember, seeking equity financing does involve giving up some level of control of your business so you have to be very selective about who you choose to accept money from. If your business encounters some difficulties or you have disagreements about the direction of the company, it can place a strain on the relationships between investors. Keep this in mind if you plan on asking close friends or family to invest in your business.
Types of Equity Financing
Individual Private Investors
One way to raise money for a business is by reaching out to individual investors. This can include your friends, family, and other colleagues. Some business owners feel like this is the easiest type of equity financing to secure since they are working with people they have a prior relationship with and who are more likely to be interested in seeing the business succeed. However, these people often do not have large amounts of money available to invest in a business, so you may not be able to get all the financing you need through any one person.
A venture capitalist can either be an individual person or a larger firm. Unlike individual private investors, venture capitalists typically have larger amounts of money to invest in a business. Venture capitalists, whether it’s an individual person or a firm, are generally most interested in finding companies with extremely high growth potential. Since venture capitalists are able to invest larger amounts of money, they will most likely expect to have a larger share of control in the company.
Angel investors can also act as individuals or as a larger group. These are investors who are capable of investing a large amount of money in a business and are most typically looking to invest in businesses that are in an industry they are familiar with and have experience working in. The name “angel investor” reflects the fact that not only can they make a large financial investment in your business, but they can also provide very valuable guidance. Typically, angel investors are interested in getting involved with businesses in their early stages.
Private equity firms and strategic investors are other types of equity financing. A strategic investor is an investor that has a very strong vested interest in seeing your business succeed. Private equity firms provide funds for businesses with an established record of success.
What To Do Before Seeking Equity Funding
Before you start pitching your business to potential investors, consult a business attorney. A lawyer will be able to create contracts for your investors to sign, which will protect everyone involved. They can also explain options to you that can limit the level of control an investor has in your business, such as non-voting stock or convertible notes.
Uses Of Equity Financing for Small Business