The Ultimate Guide to Equity Financing
Equity financing is a popular way for entrepreneurs to obtain capital without taking on debt. In this form of financing, the business owner sells shares of their company in exchange for financial compensation.
It sounds simple enough but obtaining equity financing is a big decision that’ll affect your business forever. This post will shed light on the process of obtaining equity financing and its potential benefits and downsides for different types of businesses.
How to Obtain Equity Financing:
When it comes to obtaining equity financing, you may go to one (or more) of several sources. These sources of equity financing include:
- Angel Investors
- Venture Capitalists
- Family and Friends
- Small Business Investment Companies
The process for obtaining equity financing differs depending on the source. With venture capitalists, you’ll need to show them a business plan that demonstrates a high rate of return for their investment, usually at least 25 percent, but often much more. You’ll face similar hurdles with Small Business Investment Companies, though, because these companies are backed by the SBA, their qualification criteria is generally less stringent.
With other sources of equity financing such as crowdfunding, angel investors, and family and friends, obtaining funding may be as simple as convincing people that you have a good idea. That said, a well-crafted business plan will surely improve your chances of success with these types of investors. Also, regardless of who’s investing, you’ll want to have a lawyer draw up documents to lay out the specifics of your equity financing deal.
The Advantages and Downsides of Equity Financing:
The primary benefit of financing your business with equity is its availability, short-term affordability, and limited downside risk.
Even if it’s impossible for you to obtain debt financing because of a poor credit history, you can still access equity financing. Moreover, the direct, short-term cost of equity financing is generally lower than debt financing because you don’t pay fees or interest. Finally, since you pay for equity financing with shares of your business, should the business fail, you don’t have to pay your investors back.
Of course, equity financing also has downsides which include the potential to lose control of your business as well as limited upside.
Since equity financing requires that you give up shares of your company, this type of financing can cause you to lose some or all your ownership and management rights. In fact, this is how the entrepreneur, Steve Jobs, was forced out of Apple, the company he built. In addition to that, by selling your ownership shares, you’re entitled to a smaller share of your company’s profits which limits your upside earnings potential.
Conclusion: Is Equity Financing Right for Your Business?
For any business that needs a significant amount of capital to get started or grow, equity financing could be a good fit. Of course, as the owner of the business, you must be comfortable with the terms of your equity financing deal, which can vary considerably. You must also be prepared to work with and potentially cede some control of your business to your investors.
Due to this, just because your business needs money doesn’t necessarily mean that equity financing is the right way to go. However, if you find a good deal offered by investors with whom you can have a successful working relationship, equity financing could benefit your business.
Either way, if you decide to pursue equity financing, make sure you consult a lawyer to draw up documents and look over any contracts. A lawyer can explain the legal considerations of different deal structures and draft documents that protect you and your investors.
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