In order to raise money to help grow your business, you need to give something in exchange for your raise. That comes in the form of equity – the ownership stake that an investor will have in your company.
For entrepreneurs, this is one of the most desired forms of obtaining capital. It doesn’t require the entrepreneur to pay back the amount invested and they control what percentage of ownership is given in return for the funds.
A simple example: if your company is valued at $1,000,000, raising $100,000 will require that ten per cent ownership is given up.
At the same time, giving up equity is giving up some control. Equity investors want to have a say in how the company is operated, especially in difficult times, and are often entitled to votes based on the number of shares held. So, in exchange for ownership, an investor gives his money to a company and receives some claim on future earnings.
Some investors are happy with the growth in the form of share price appreciation; they want the share price to go up. Other investors are looking for principal protection and income in the form of regular dividends.
When fundraising, the entrepreneur sets (or obtains) a valuation for their company – an estimation of what their company is worth at a specific point in time. The amount of money that an investor provides will be reflective of the valuation and they will own a percentage of your company. Should your company continue to grow, the investor will receive compensation for their investment if/when your company sells, or when it issues its Initial Public Offering (IPO).
It is imperative that you have a valuation and one that is reasonable. Too high of a valuation will make it difficult to raise funds, too low of a valuation while very attractive to investors will result in greater dilution of your company. Here is a link to our blog post on how to handle the valuation question.
Advantages of Equity Funding
Funding your business through investors has several advantages, including the following:
The biggest advantage is that you do not have to pay back the money. If your business enters bankruptcy, your investor or investors are not creditors. They are part-owners in your company and because of that, they share your business risk.
You do not have to make monthly payments, so there is often more cash on hand for working capital.
Investors understand that it takes time to build a business. You will get the money you need without the pressure of having to see your product or business thriving within a short amount of time.
Disadvantages of Equity Funding
Similarly, there are a number of disadvantages that come with equity funding, including the following:
How do you feel about having a new partner? When you raise equity funding, it involves giving up ownership of a portion of your company. The riskier the investment, the more of a stake the investor will want. You might have to give up 50% or more of your company. Unless you later construct a deal to buy the investor's stake, that partner will take 50% of your profits indefinitely.
You will also have to consult with your investors before making decisions. Your company is no longer solely yours, and if the investor has more than 50% of your company, you have a boss to whom you have to answer to.
Overall, equity funding is one of the great ways of getting funding when you are not willing to pay something in return but rather give a part of your company’s future success.
Are you looking for equity funding for your company? Our team has helped many new companies achieve their aspirations. Please contact us here if you’re interested.