Equity Funding Basics
Equity Financing Basics
For most businesses there are two types of financing: debt and equity.
- Debt financing is a loan. The lender gives you money and you promise to pay it back with interest—the cost of borrowing the money.
Equity funding means selling a piece of your business. An investor gives you money in exchange for owning a piece of your company.
What do investors want?
Investors want a significant return on their investment. Generally, an investor wants at least a ten times return on their investment in 5-7 years through an “exit.” This is why equity financing is for high growth potential companies, such as tech startups or multi-location restaurants.
What is an “exit?”
An exit is the sale of the company to another company, a private equity firm or new investors through an initial public offering (IPO). When the company sells, those who have equity split the proceeds.
Who are the investors?
Friends and Family: The first people to invest are often the founders’ friends and family. Remember, once money is involved your friends and family become investors, and as such, you need a structured agreement with them called a term sheet.
Angel Investors: The first round of formal equity financing is typically from angel investors—those who invest their own money. Angels fund a few thousand to around $1 million as individuals or together in structured angel groups.
Venture Capital: Unlike angel investors, VCs invest funds from others. Their investments start around $2 million and they usually focus on later stage companies that are showing significant growth trends. VCs like to see a 30% return on their investment each year.
Tips before going after equity investments:
- Confirm that your business has the growth potential equity investors like.
- Make sure you’re comfortable with the idea of an exit.
- Be aware that you could lose control of your company.
- Join a local (or virtual) accelerator or incubator. They often provide education, mentorship and equity financing connections.
- Calculate the time and energy it takes to get funding—it’s not easy! Can you get customers to finance your growth for the same effort?
- Use a lawyer who knows equity funding deals. A lawyer can save you time, money and protect your interest during tricky negotiations.
- Select your investors carefully. A good fit can bring industry connections and insights along with funding to your business.
- Research which areas different equity groups fund and target your efforts.
- Gain needed funds for product refinement and company expansion
- Owners do not have to pay back the funding.
- Investors often bring experience and connections into the industry
- You give up control, and yes, founders have been kicked out of their own company.
- You could lose control of your company.
When it comes to equity funding, women and minority owners have historically had a harder time accessing capital. According to VC firm, Invest Her Ventures, only 3% of VC funding goes to women-led companies. The reason for this discrepancy are complex, but it is starting to change. There are a growing number equity firms looking for women-led businesses to fund.
Click HERE to find a list of Angel and Venture Capital groups that focus on women.
Like women entrepreneurs, entrepreneurs from the African-American and Hispanic population can have a hard time being funded by traditional venture capital firms. According to Forbes, less than 1% of equity funding goes to business owners with minority founders. The percentage of decision makers in equity firms is about the same.
Click HERE to find a list of Angel and Venture Capital groups that are trying to change that fact.
The U.S. Securities and Exchange Commission has an interactive tool that can help you navigate the many regulatory pathways to raise capital, based on the criteria that matters most to you. While this tool does not provide legal advice, it can help you better understand your options so that you make more informed decisions.