Equity Financing for Your Business
Early-stage businesses with potential for growth can consider equity financing for their funding needs. This type of financing is provided by individual and group investors rather than banks or other financial institutions.
Unlike traditional loans, you don’t have to repay the funds you receive from equity investors. Instead, the investors get a percentage of ownership in your company, earning them a share of profits as your business grows.
What is equity financing?
Equity financing is a way to generate funds for your business through the sale of company shares. With equity financing, startups and recently established companies with limited cash can approach wealthy individuals or investment firms to see if they want to back their great ideas.
You can get equity financing from individual or angel investors, as seen on the popular show “Shark Tank.” Or you can raise funds via a crowdfunding platform or through a venture capital firm.
While you don’t have to repay the funds like with small business loans, you do have to give up a percentage of ownership in your company. However, you also gain expert knowledge from your investors when you bring them on board, which can help strengthen your business model.
Types of equity financing
Individual investors
You can ask your friends, family and colleagues to contribute funds to your business in exchange for a share of equity. Since each individual will likely contribute a small amount, you may need to recruit multiple investors to reach your funding goals.
Individual investors may not have experience in your field, or the relevant business skills to help provide support along the way. And, depending on the amount of equity granted, some investors may consider themselves partners in the business, and expect a say — or even equal vote — in business decisions.
Carefully consider — and discuss — exactly what an equity stake would look like before taking on investors. And keep in mind that you could risk straining close relationships if your business doesn’t succeed, especially if they invested a significant amount.
Angel investors
An angel investor is typically someone with a lot of wealth who helps fund startups — as long as they have potential for high returns. Often, angel investors have experience in the same or related fields and can offer guidance and support to ensure your business succeeds.
You can search for angel investors through your professional network or use a platform like AngelList or the Angel Capital Association.
Venture capitalists
Venture capital financing is similar to angel investing, but with funds coming from a firm instead of individuals. Venture capital (VC) investors typically require at least 20% ownership in your company and will have a say in business decisions. But they also act as a strategic advisor, helping connect you to industry experts to take your business to the next level.
While angel investors like to support early startup businesses, VC is generally reserved for businesses that are established but still growing. If your company is too young, a VC firm might worry about its long-term potential. And if your business has been running for more than eight years, there’s fear that you’ve passed the opportunity for fast growth.
Equity bridge financing
Bridge financing, or a bridge loan, can be used to cover urgent funding gaps while a company waits to secure long-term financing. If you don’t want to take on debt with high-interest rates, you could consider equity bridge financing with a venture capital firm.
With this option, the investment firm provides financing for a specified period in exchange for equity ownership in your business. The timeframe for funding can range from several months to a year — although the firm will keep ownership after the funding period ends.
Venture capital firms often take the risk to help a struggling business if they see a strong potential for growth, especially since they’ll be able to reap the returns for years to come.
Crowdfunding platforms
Crowdfunding for business involves creating a public fundraising campaign to collect donations from friends, family and the general public. Popular crowdfunding platforms include GoFundMe, Kickstarter and Indiegogo.
While you don’t need to repay the donations you receive, some platforms require you to give something in return, such as discounted rates, free t-shirts or VIP access to events. Additionally, most crowdfunding platforms deduct a small fee for their services and some will only release the funds if you meet your full financial goal.
Initial public offerings (IPOs)
Bigger companies with a solid track record can consider raising funds through initial public offerings (IPOs), which is where you sell company stock to the general public. However, businesses typically need to operate for around eight to ten years before exploring this option.
For smaller companies wanting to sell stock shares, you can start by offering over-the-counter (OTC) stocks on the Pink market. This is a trading platform for stocks not listed on the major exchanges. Keep in mind that you usually need some shareholders on board before offering any type of IPO.
Debt financing vs. equity financing
Pros and cons of equity financing
| Pros | Cons |
|---|---|
No interest charges or repayment terms. Access to experienced industry leaders. Higher funding amounts. Flexible qualification requirements. | Giving up a portion of ownership. Sharing control with investors. Can be more expensive than borrowing. Must have a business that shows high potential for growth. |
How to get equity financing for your business
1. Decide how much you need
Look at your business budget and calculate your most immediate funding needs. If the amount is relatively small, you might find it easier to apply for a small business loan. However, investors could be a better fit if you need significant funds or access to ongoing funds.
Your investor will want to know how much you need and what you plan to use the funds for, such as building an expansion, upgrading equipment or branching out into a franchise.
2. Gather important documents
Make sure to have your business’s essential paperwork on hand when approaching equity investors. While the required business documents will vary based on the investor or firm, here are some standard documents you might need:
3. Find investors
If you don’t have any connections with investors in your personal or professional network, you can search on LinkedIn or try using an online platform.
Here are some options to consider:
4. Negotiate the equity split
After picking an investor or firm, you will likely need to do a business valuation to determine your company’s overall worth. Knowing this can help investors negotiate the estimated price per each equity share. Your company’s time in operation, cash flow projections and general market trends can help influence the equity share.
Most venture capitalists want around 20% to 25% ownership in your company, while angel investors typically want between 20% to 50%. Remember, the equity share lasts forever or until the investing firm sells it back. This means you will hand over that percentage of profits as long as your company continues to operate.
5. Use the funds to grow your business
Once you’ve agreed on an equity price and share amount, the investor will release the funds to your business checking account. From there, you can use the cash to tackle your company’s most pressing needs, such as hiring new staff, refinancing business debt, purchasing new equipment and more.
6. Share the profits
As your business starts turning a profit, you will need to release the agreed-upon percentages to your investors. Payments are usually sent as dividends and is something your bookkeeper or accountant can help with — or you can use small business accounting software to do it yourself.
If your startup fails, you typically don’t need to repay the original investments. This is a risk investors take when they sign up to back your business.
When is equity financing a good idea?
Equity financing could be a good fit if your company is already established but needs an extra boost to reach the next level of success. If you have a limited credit history and can’t qualify for traditional financing but have a solid business plan in place, you might have better luck with an equity investor.
Additionally, some equity investors have extensive knowledge in your field and are committed to teaching you business strategies to improve your business model. In this sense, equity financing gets you funding plus a supportive business partner.
However, your business must show potential for growth to appeal to equity investors. If you’re a brand-new startup in a risky field, you might want to consider alternative funding methods instead.
Alternatives to equity financing
There are many advantages to equity financing, such as helping you get funds during the early stages of your business without incurring debt. That said, it might not be the best fit for your company’s needs. Here are some other types of business financing to consider:
Business loans
A short-term business loan can provide a lump sum with scheduled repayments, typically lasting three to 24 months. Your interest rate will vary based on factors like your time in business, credit score and annual revenue. In general, traditional banks offer the most competitive rates, while online lenders have less-strict eligibility requirements.
If you need access to occasional funds, a business line of credit could be a good option. You can borrow up to a set credit limit as often as needed, only paying interest on the amounts withdrawn. However, some lenders also charge additional maintenance or withdrawal fees.
Business grants
There are a range of small business grants offered by the state and federal government, as well as corporations and nonprofits. You can search based on your type of business, location or demographics, such as business grants for women or minority small business grants.
While finding the right grant for your business can take time and effort, it can be worth it since this is free money you typically don’t need to repay.
Business credit cards
Business credit cards are typically easier to qualify for than small business loans and can help cover everyday or low-cost expenses. In addition, some credit cards offer generous welcome offers and travel rewards.
However, credit card borrowing limits don’t usually go as high as other types of small business financing. Since interest rates tend to run high, it’s best to pay off your full balance every month.
Bootstrapping your business
If you have some money set aside in savings, you could use it to bootstrap your startup. The main benefits include keeping 100% ownership in your company while avoiding debt.
However, you run the risk of not having enough money to cover basic startup costs or having extremely slow growth. Plus, being a one-person team means you can’t tap into any additional resources like when working with an investor.
Friends and family
You can also use a family loan to help support your new business. Even though this transaction may feel more casual than getting a bank loan, it’s still worth writing up a loan agreement outlining the terms and interest rates.
Also, make sure that owing money to a friend or family member won’t strain the relationship, especially if your business fails to succeed.
Sell your business
If you’re hard-strapped for cash, another option is to sell your business while staying on as an employee, CEO or partial equity owner. You could negotiate your future role or equity share in the company during the sale instead of accepting a clear lump-sum payment.
While this option requires you to give up ownership, which could be hard if you built the startup from the ground, it can help alleviate financial pressure. You might find a more established company to take your smaller company under its wings, with the potential to earn even more than when you were running things all by yourself.