Equity financing means selling a stake in your company to investors who hope to share in the future profits of your business. There are several ways to obtain equity financing, such as through a deal with a venture capitalist or equity crowdfunding. Business owners who go this route won’t have to repay in regular installments or deal with steep interest rates. Instead, investors will be partial owners who are entitled to a portion of company profits, perhaps even a voting stake in company decisions depending on the terms of the sale.
Types of equity financing – These are some common types of equity financing:
Angel investors. An angel investor is a wealthy individual who gives a business a large cash infusion. The angel investor gets equity – a share in the company – or convertible debt for their money.
Venture capitalists. A venture capitalist is an entity, whether a group or an individual, that invests money into companies, usually high-risk startups. In most cases, the startup’s growth potential offsets the investor’s risk. In the long run, the venture capitalist may look to buy the company or, if it’s public, a substantial portion of its shares.
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Equity crowdfunding. Equity crowdfunding is when you sell small shares of the company to numerous investors via crowdfunding platforms. These campaigns usually require immense marketing efforts and a great deal of groundwork to hit the goal and get funding. Title III of the JOBS Act lays out the specifics of equity crowdfunding.
Angel investors and venture capitalists are often highly experienced, discerning investors who won’t throw money at just any project. To convince an angel or VC to invest, entrepreneurs need a pro forma with solid financials, some semblance of a working product or service, and a qualified management team. Angels and VCs can be difficult to contact if they’re not already in your network, but incubator and accelerator programs often coach startups on how to streamline their operations and get in front of investors, and they may have internal networks to draw from.
“It’s true that equity often doesn’t require any interest payments like in the case of debt,” said Andy Panko, owner and financial planner at Tenon Financial. “[But] the ‘cost’ of equity is typically higher than the cost of debt. Equity holders will still want to get compensated somehow, [which] generally means having to pay dividends and/or ensuring favorable equity price appreciation, which can be difficult to achieve.”