Every business is different when it gets started, and therefore every business has different needs. Some need no funding at all, and can get off the ground with the same amount of time and money that it would take to sell lemonade on the street corner. But others need not only money to get started, but money at regular stages of its growth cycle, as the company transforms from startup into success.
Equity financing exists for the companies that need capital to grow and scale. And if your business needs to raise money in order survive, here are the essentials that you need to know.
What Is Equity Financing?
Equity financing is a method of financing in which a company issues shares of stock and receives money in return. Investors may earn a dividend, though they are far more likely to realize value from their investment when the company is sold or goes public.
Equity investments can come from friends and family, angel investors (offline or through crowdfunding platforms), venture capitalists (VCs) or private equity firms. You can also seek equity financing from the public in the form of a mini IPO, as detailed under Title IV of the JOBS Act, Regulation A+, or following a traditional initial public offering (IPO).
Since startups don’t raise money from private equity firms and the public, this article will focus only on friends and family, angels and VCs.
Why Raise Equity Financing?
From an entrepreneur’s perspective, offering equity is less risky than taking out a loan because there is nothing to pay back. Since you don’t have to funnel profits into required loan repayments, you’ll have more cash on hand for expanding the business.
Equity financing is commonly associated with angels and venture capitalists that look to fund companies—especially technology and life science companies—that will scale really big. So, if your business needs immediate funds in order to scale, equity financing can be a great option.
There are downsides, however, which are certainly worth thinking about. If your business fails, you will have to deal with angry investors; an especially uncomfortable prospect if your investors are friends and family. And even though there is no requirement to pay your investors back, that ownership stake may cost you in other ways.
In exchange for equity, you may assume an obligation to share any future profits with your investor, or even allow him or her to influence how you run your business. Also, finding the right investors can be time-consuming, which is time you could have spent in other productive ways.
As previously mentioned, equity financing is usually associated with angel investors and venture capitalists.
An angel investor is an accredited investor whose net worth is greater than $1 million (excluding a primary residence), or whose individual income exceeded $200,000 ($300,000 for couples) for the past two years with the expectation for that income to continue in the current year.
Angels usually target companies in early, pre-seed stages. Venture capitalists are partners that pool together large amounts of capital that are managed by select partners in the firm. These firms target billion dollar-plus industries and are looking for a big return on investment.
There is some fluidity, however, among investors in the types of companies they choose to invest in. Some angels target investment opportunities similar to those targeted by VCs: large lucrative industries and companies that they think will deliver a big payoff—five to ten times return on investment (ROI), according to Kauffman’s Entrepreneurship.org. Others want to help passionate entrepreneurs turn their dreams into reality.
Whatever their motivations, they’re investing lots of money. Angels invested $24 billion in companies in 2014, according to the Center for Venture Research. Venture capitalists invested $70 billion in 2014, but only 4.5% of that was seed-stage investment, according to PitchBook. In spite of these figures—and most relevant to small business owners—the reality is that only 6% of small business financing for young companies comes from angels and venture capitalists, according to the Kauffman Firm Survey, 2008.
It might even further surprise you to learn that friends and family bankroll startups in a big way. According to Fundable, they invest $60 billion per year.
Where to Find Investors
You know where to find your friends and family, so you don’t need advice on that. Locating angel investors and VCs takes a bit more work, but online directories and many other resources can assist.
ACE-Net is an electronic network of angel investors developed by the Small Business Administration (SBA) that helps angel investors and small businesses connect online. The Angel Capital Association is another resource, which can help you identify a local group of angel investors in your area.
AngelList and TechCrunch are also good resources that provide information on companies and the angels that have invested in them. As for offline options, don’t forget about attending local pitch events and demo days, which many angels frequent. You should be able to find local events at some of the aforementioned resources.
Equity crowdfunding platforms can also put you in touch with investors. Accredited equity crowdfunding platforms pool money from a group of investors online, using social media and other types of marketing. Platforms like AngelList, CircleUp, Crowdfunder and Portfolia centralize, streamline, simplify and shorten the fundraising process. Many of these platforms offer access to investors.
For a list of platforms, go to Stand Out In the Crowd: How Women (and Men) Benefit From Equity Crowdfunding. You can learn how to ensure a successful crowdfunding campaign, and also learn about the current state of equity crowdfunding.
As for VCs, most don’t invest in seed-stage companies. For a list of the top firms that do, read this article in Entrepreneur. Services like Boogar, MyCapital and VCgate, among others, provide more in-depth lists of VCs.
When to Seek Investors
Raising money in the offline world can take seven to 12 months—sometimes even longer. On equity crowdfunding sites, it takes four to six months on average to secure investors, according to Luan Cox of Crowdnetic, which aggregates data from 18 equity crowdfunding platforms.
If angels and venture capitalists are not part of your current network, it may take some time—a year or two—to build solid relationships with them. So, with respect to finding your potential funders, start early and plan your strategy accordingly.
How to Pitch Investors
Focusing your search by identifying suitable angels, VCs and friends and family ahead of time will increase your chances of success. VCs and many angels like to invest in companies whose business they know something about. Concentrate on people who have an interest in your industry. Target investors interested in your company’s stage and deal size.
While some investors do read plans that come over the transom, they pay far more attention to plans referred to them by a trusted source, such as a business associate, lawyer or accountant. Another way to meet people with deep pockets is to present at—or at the very least attend—a venture capital conference or angel club meeting. Network to find out about these opportunities.
Also, don’t forget about friends and family, which can be great sources of capital. There will be, however, more strings attached. You should be just as professional when raising money from loved ones as you would be with people you don’t know. Do provide a business plan, explain the risks and formalize the relationship with an agreement.
Equity financing can play an important role even in the early stages of your company’s formation. Educate yourself on the ins and outs to understand when, why, and how it can help you grow your business.