Since most new businesses need capital to grow, it’s vital to explore all funding options so you can make an informed decision for your business. For some businesses, a sound option may be equity financing.
What Is Equity Financing?
Equity financing is the process of raising money in exchange for ownership shares in a business.
The size and scale of equity investments vary and are usually dependent on the industry your business is part of and its startup stage. Early-stage businesses might raise some money from family and friends, while established businesses could solicit multi million-dollar investments from venture capital firms.
Equity financing has some components that may be advantageous compared to other financing options for some businesses. Generally, investments don’t have to be repaid with monthly payments, which can free up much-needed cash flow for young businesses. Additionally, investors with prior industry experience can serve as advisors and may contribute invaluable guidance.
On the other hand, finding and pitching investors can take a large investment of time, effort, and patience, as you might need to make several presentations before an investor match is found. In addition, you also need to determine how much of your business you want to offer to equity partners. To maintain control of your company, a good rule of thumb is ensuring you retain at least 51% ownership.
Who Are Equity Investors?
There are a number of different types of equity investors. The type of investor you’ll attract usually depends on the industry, stage, and size of your business. Some investors are strictly interested in early-stage businesses, when the risk is highest but so is the possible return on investment. Other investors might seek more-established businesses with proven track records.
Here’s a quick primer on some of the different types of investors:
- Friends and family: Often the first people small business entrepreneurs turn to, friends and family make investments that are usually minimal, but may be essential to getting your business up and running
- Angel investors: These are high-net-worth individuals who usually have experience in your industry. They’ll invest early in your business and may offer valuable advice and guidance.
- Venture capital: Venture capital is typically a separate fund that invests in businesses with high potential returns. They can invest a substantial amount of money but will usually require a large ownership stake in exchange.
- Private equity: This is a separate fund that invests in proven businesses with substantial earnings. Private-equity firms can also purchase a company outright.
- Strategic investors: These are individuals or businesses that have a vested interest in the success of your business. For example, a coffee shop might have a bean roaster as a strategic investor.
What About Crowdfunding?
Crowdfunding is when a project or business raises small amounts of capital that can add up to a big amount from a large group of people—usually online.
Typically, people who “donate” don’t receive an ownership interest in the venture but might receive a small reward, such as a sample of the product being funded. Well-known crowdfunding sites include Kickstarter and GoFundMe, among others.
Crowdfunding is usually used to test, promote, validate, and gather feedback on early-stage ventures and products to determine whether they are worth large-scale investment. If you have a validated idea with some market traction, equity financing might be a better route for your business than crowdfunding.
Additionally, crowdfunding is customer-centric, whereas equity financing is investor-centric. If you’re seeking market validation for an early-stage physical product, crowdfunding might be a good option. If you want to grow operations by selling an ownership stake to investors, you may want to consider equity financing.
How Complicated Is the Process?
Landing equity investors can require a significant investment of time and money. Between preparing the necessary documents and presentations, finding and vetting interested parties, and pitching and onboarding investors, the process can take as little as a few months to as long as a couple years.
Additionally, selling equity in your business will involve securities law. As such, you’ll need to consult a corporate securities lawyer in order to make sure your offering is SEC compliant. As an alternative, there are new equity-funding platforms that connect businesses with lawyers, expand the reach of your offering and, in general, facilitate and expedite the process.
Consider Your Options
Equity financing isn’t ideal for every business. Conducting due diligence for all funding options can help you to determine the right funding route for your business.