Business Guides

The Beginner’s Guide To Equity Financing

Last updated on September 24, 2020

Jacques Famy Jr

Starting a business requires significant capital, and while many companies have similar starting costs — there may be a need for additional financing.

Whether it’s stocking inventory, continuing marketing efforts, working capital, materials, or even opening up a storefront location — finding the right funding can be a challenge. There are two options for most businesses without a substantial amount of personal savings or operational revenue on-hand.

  1. You can go into debt
  2. You can seek investors or financing options

While option #1 may have some upsides for a small portion of businesses, there’s always option #2. There’s a ton of ways companies can seek and discover funding opportunities that work for them, with various alternative financing options emerging every day. Today, we’re going to be discussing one of the more popular ways to receive capital for your business through equity financing.

Equity Financing 101

Equity financing is actually quite simple. It refers to the process of seeking investors, but there is a slight caveat to the ordeal. When looking for a financial relationship, you’ll be giving up a portion of ownership to your business.

If you’ve ever seen the show Shark Tank, you’ve witnessed equity financing at work. Investors in the equity financing arena are looking for quality businesses with a bright future and a potential for major earnings. So, while the typical equity financing process may not look as glamorous or dramatic as the television show — it does involve making a pitch and weighing the pros and cons of the deal.

Giving up part ownership in your business for an agreed-upon sum of money requires careful research, negotiation, and consideration. While your business may be in dire need of cash flow, handing out part of the ownership in a company has a severe impact on the business’s future.

Both the business owner and the investor are taking a risk — but it’s the investor’s money on the line. So, you’ll need a strong business plan, proof of potential growth, and data to show that your business — means business.

Various Funds in Equity Financing

Equity financing refers to a type of funding opportunity, but there are various models that business owners can seek out. Depending on the health of your business, what stage it’s at, and the level of funding you need — you’ll have to make a sound decision about which equity financing solution works for you.

Venture Capital

Venture capital (VC) opportunities are usually aimed at high-growth and young companies that are on the rise and have a significant potential for return on the investment. While many businesses look for funding from banks or more traditional sources of financing, venture capitals are another route.

Typically, VCs will assist high-risk companies without guarantees or collateral requirements. For young businesses, this can be a great opportunity as traditional funding sources may be out of reach at this stage.

Venture capital can be specialized, targeting very specific industries — or they can general. Regardless of the type of VC, a portion or stake in the company will always be requested. Due to the high-risk investment, VCs usually participate in the business to some degree, as their money is on the line. They may:

  • Act as a consultant
  • Become a part of the board
  • Engage in financial conversations
  • And possibly more

Some business owners are afraid to let go of the reigns or delegate that much responsibility to a stakeholder, but it can be a major benefit with the right VC. Venture capitalists have a ton of expertise and a “big picture” understandings of running successful companies. It’s also typical for VCs to want an end goal or what’s known as an “exit strategy.” This could be going public or getting acquired by a big name — as this illustrates the value and potential return they’re looking for in their investments.

Small Business Investment Capital (SBIC)

The Small Business Administration (SBA) regulates privately owned Small Business Investment Capital (SBIC) opportunities. These private companies leverage SBA-guaranteed loans and their own funds to offer equity financing to small businesses nationwide. While SBICs are known for their debt financing, they do provide investments for those who qualify.

If your business is qualified as a small business, you’re more than likely eligible. There are some factors that could deter approval, such as specific industries or a portion of employees outside of the United States. SBICs are not a fast financing solution, as it can take several weeks to obtain a final decision. You’ll need to submit a solid business plan and follow the instructions laid out in the SBAs website.

Angel Investors

For some business owners who are just starting out, angel investors may be a sound financing choice. Individuals, incubators, groups, and even VCs that are just getting their feet in the door are looking to invest in the early stages of a companies lifespan for a stake in the business.

If it’s not obvious, angel investors are not experienced VCs. So, if you’re looking for the quality advice or expertise that you would get from a venture capitalist, you’ll have to keep looking. Now, that’s not to say all angel investors lack experience, but they’re not as likely to work alongside the business.

Crowdsourcing

While VCs, SBICs, and even angel investors aren’t new — crowdsourcing is a relatively modern route to equity financing. Unless you’ve been living under a rock, you’ve seen crowdsourcing efforts on your social media pages or even in your email inbox. Now, not all crowdsourcing efforts entail equity in a company, but it is a popular model of receiving investments in the very early or developmental stages of a product or service.

Typically, crowdsourcing is all about advertising efforts and marketing strategies, as you’ll have to compel everyday people into investing in your business and help get your ideas off the ground. Whether it’s through offering packages based on levels of investments or sending prototypes or early-stage products to customers — crowdsourcing is a lot of work. However, that doesn’t mean it’s not worth it for the right business.

It’s a fantastic way to test out the potential success of your business and get a genuine reaction from a potential customer base.

Wrapping Up: Equity Financing In a Nutshell

Equity financing requires proven success and potential growth, and investors won’t just offer funding out of the kindness of their own hearts. You’ll need a solid pitch that outlines the entirety of your business and future plans. At the bare minimum, it should include:

  • The UVP (unique value proposition) or specific problem your product or service solves
  • How there’s a demand for your company
  • Revenue model
  • Market share

Be prepared to answer questions and have a robust understanding of how much stake in the company you’re willing to let go of.

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