A Beginner’s Guide to Equity Financing for Small Businesses
How much money do you need to get your business up and running? Every business has many of the same costs, like registering the business and initial marketing efforts, but does your business require a little more? What about a storefront? Construction materials? Clothing to fill your boutique?
If your business needs a substantial investment to get started (or to get to the next stage), you may not be able to cover the costs with your personal savings or operational revenue. In that case, you have two options: you could go into debt, or you could seek investors. Both options have their merits, but you should know what you’re getting into before you get started.
Let’s take a deep dive into equity financing. (You can find more information on debt financing in our recent blog post.)
What is Equity Financing?
Equity financing is simply the process of seeking investors for your business. (If you’ve ever watched Shark Tank, you’ve seen this in action.) It’s almost a cliche of starting a business, the idea that you’ll be pitching your prototype, answering questions, and asking for money.
Equity, another word for ownership, is an apt name for this financing model. When you bring on an investor, you’ll be giving up part ownership of your business. Both the percentage ownership and sum of money should be carefully negotiated with your investor because it’ll have major impacts on the future of the business.
Keep in mind that the investor is taking a risk when they choose to go into business with you. If your business doesn’t succeed, they won’t have any return on their money invested.
Types of Funds in Equity Financing
There are multiple types of investment that you can leverage depending on the stage of your business and your needs. There are:
Venture capital (VC) is a fund that typically invests in young, high-growth companies with high-potential returns. If you can’t seek investment from more traditional sources like the public or banks, you could opt to work with a VC.
VCs take on high-risk companies without asking for collateral or guarantees, making them a good alternative to their conservative counterparts. A VC could be general or specialized, focusing on specific industries or technologies to invest in. They don’t expect an immediate or even quick return on their investment, but they’ll work to make sure you meet specific targets or milestones.
They will always ask for a stake in your company, and they almost always actively participate in the business. This could be through providing advice, being part of your board, etc. This could sound like a drawback, but their expertise could and long-term view of business could be the voice your company needs to steer towards success. VCs also want to hear about an “exit strategy” - how you plan to create the value they can realize, like being acquired or going public.
If you’re an early-stage company, angel investment could be the right choice for you. Angel investors and groups, incubators, and early-stage VCs are individuals or groups with high-wealth that want to invest in a product during very early stages of the business.
Since investment in an early stage business comes with higher-risk, not all investors want to work alongside the business or even have enough expertise to evaluate a company’s chances of success.
The amount of money you receive will depend on the stage of your business and your success so far. If you can prove that your business has a market, you could recieve up to $2,000,000.
Crowdsourcing is a more recent method of raising money for your small business. If you have a Facebook account, it’s likely you’ve come across this method before. You can list your business or product online (using one of the many crowdfunding platforms) with a video and compelling advertisements. As potential future customers come across your page, they can give you money to get off the ground.
Whether or not you promise something in return is dependent on your product or service. Usually, manufactures with a physical product promise to send the product once complete in exchange for investment. In this way, you essentially have an early buyer. You can also guide investors by offering specific packages for different levels of investment.
Crowdfunding is a great way to raise money, bring in early customers, and test your ideas all at the same time. However, it can be difficult to guarantee your success. You’ll need to look at this at an early sale of your product, and you’ll need to strategically appeal to the right customers. You can use social media marketing, videos, and graphics to find the right segment.
Small Business Investment Capital (SBIC)
SBICs, which are regulated by the Small Business Administration, are privately-owned investment companies. These companies use their own funds and SBA-guaranteed loans to provide a mixture of debt and equity financing for small businesses. While they most commonly provide loans for debt financing, these companies do offer investments.
If you decide to work with an SBIC, you should first qualify as a small business and ensure that they are allowed to invest in your business. (For example, your industry or number of employees outside the US could disqualify your company.) Once you’re sure you qualify, you’ll need to submit your business plan and follow the instructions on the SBA website. A decision could take several weeks.
How to Win With Equity Financing
No matter the route you take within equity financing, you’ll need to rely on more than just an investor’s generosity. The amount of money you receive through this process will vary based on your proven success and the chances of your success moving forward.
When you decide to pitch your business, make sure you cover your bases. Your typical pitch should include the problem your business solves and the demand for your business, your revenue model, and your market share. Beyond this, you should also anticipate your audience’s questions with an appendix, which easily shows the answers to their questions as soon as the questions have been asked.
Think carefully about the amount of your business you’re willing to give away. Both in decision-making and in your future income, you wouldn’t want to regret giving away too much of your company.