To sell or not to sell, that is the question. No, we’re not talking about products and services, but about company equity. Every small business requires funds and financing to get up-and-running. Unless you’re independently wealthy, you’ll be faced with two choices: taking out a loan or selling a portion of your business to an investor. There are pros and cons to each approach, and it’s worth examining each in some depth before you come to a final decision. To help you decide, here’s a quick look at the benefits and disadvantages of the second approach: equity financing.
Benefits of equity finance Taking out a loan means that you’ll have to pay interest; as a result of this a portion of your monthly earnings will be off limits to you. Should your business suffer—for example, if you’re unable to turn a profit because of limited demand—you’ll be answerable not just to your employees but to the lending agency as well. This would not be the case with an investor, particularly if they were aware of the risks associated with the business before becoming a minority partner.
Sources of equity finance
Venture capitalists: Venture capitalists often choose to finance businesses at various stages of their growth. When operating in an individual capacity, they are referred to as angel investors and are called venture capital firms when they function as a registered company.
Such individuals/entities enjoy funding high-risk, high-return ventures. Venture capitalists often decide which stage of a business’s growth they wish to intervene in, which often depends on their assessment of the risk: benefit ratio. Each round of investments is referred to variously as ‘seed funding’ (the start-up phase); ‘second-round/second stage funding’ (when a business is scaling up) and ‘bridge funding’ (the period preceding the public-option phase.)
Royalty financing: Here the investor funds a particular business asset or vertical, in hopes of raking in a portion of future profits, or with the intention of buying the appreciated asset(s) outright from their owner.
Things to keep in mind
Co-ownership: Since the investor is a co-owner, she is legally entitled to a role in decision-making.
Portion control: In return for the relative stability of a partnership, the investor gets to command a larger portion of your profits than a lending agency does. Depending on the level of investment you’re looking for, you can expect to relinquish a claim to 25%to 75% of your stake in your business.
Size matters: Typically, though, experts recommend considering debt-financing (loans) if you’re a small company, with no immediate plans to scale up in a big way. Venture capitalists and angel investors prefer companies that are interested in establishing a global presence, with plans to generate proportionally large returns.
The middle path: Start-ups also have the option of combining both types of financing, i.e. debt and equity at different stages of their growth. When they’re just starting out, they might choose to borrow money from family and friends or a financial institution. As their business picks up, they might decide to augment these funds by taking the equity route. Equity financing is just one of many options that a (soon to be) small business owner has at her disposal, and deserves due consideration.