Equity financing is not just for raising money for growth but about building an investor base that can help with more than just funding.
Imagine having $50K to grow your business plus experienced business owners to help you decide where it will go the farthest.
That’s what equity financing can do for your business and it’s not just for giant million-dollar enterprises. In fact, once we get through the technical stuff around business funding, I’ll show you why everyone should consider it as a way to grow your business.
My experience with equity financing is on the investor side, analyzing deals for venture capital looking to invest in startups. I worked with entrepreneurs to find a fair price for the shares and calculate potential return for investors.
Done right and it can be a great opportunity for both investors and entrepreneur.
Here’s how to do just that!
What is Equity Financing?
Equity financing is any investment in your business that gives the investor an ownership stake. The most common form of this is when a company sells shares on the stock market but that leaves out a huge opportunity for small business owners.
Equity financing can be raised in a couple of different forms from preferred shares to common equity but both give the investor a share of future cash flows from the business.
Businesses raise equity financing because it’s less risky than debt, there’s no guarantee to investors and no payment obligations. Selling shares can also bring resources and additional marketing to the business.
What are the Types of Business Financing?
A lot of online entrepreneurs and small business owners choose to ‘boot-strap’ their business, providing all the funding themselves. It’s a safe strategy because you don’t have debt payments or investors, but it also misses out on a lot of opportunities to reinvest for growth.
Let’s look at some of the ways you can raise money to grow your business and then why you need to consider each.
- Debt financing is borrowing against either the business itself or against your own personal assets. The advantage to a loan is that rates are cheaper than the return investors will demand and you don’t have to share profits. The disadvantage is the risk in that payment obligation.
- Equity Financing
- Partnership financing is when one or more investors own an equal share of the business. Partners usually have more control over day-to-day decisions than ordinary investors.
- Preferred shares give investors a right to cash flows before other owners but may not give the investor the same upside potential, i.e. the share price may be capped to a certain point. Sometimes, preferred shares are convertible into common shares.
- Common shares give investors a full pro-rata ownership in the company but no guarantee of returns. This may or may not include voting rights in major business decisions.
Why You Should Use Equity Financing for Your Business
Now that we have all the technical stuff out of the way, let’s talk about why even small business owners and bloggers should consider equity financing.
I’m actually surprised there aren’t more blogs and online businesses that raise money through investors. Bringing on investors can provide cash flow in those early years to spark growth that would otherwise take years to produce. As a small business with less than $100K in annual sales, you’re probably not going to get approved for debt financing.
More than the money, investors can be a base of marketing for the business that could take your website viral.
Equity financing can seem like a complicated and technical way to raise money, but it can be as simple as writing out a contract between the business owner and a group of investors.
- Business owners get funding to hire staff or outsource projects they otherwise wouldn’t have time to do themselves.
- Financing can jumpstart outreach for a business that would otherwise take years.
- Investors provide an enthusiastic base of cheerleaders and marketing for the business.
- Investors can also bring business experience and other services to the company.
- Investors get the potential for double-digit returns on an alternative asset. I doubled my monthly income in each of the three first years of my blogs and still grow it by 20%+ a year.
What are the Major Sources of Equity Financing?
Sources for equity financing range from the regulated markets to small investor groups. For the small business owner, you’re probably not looking to raise billions through an IPO but will still have access to different sources.
Again, most people will think of equity financing as issuing shares on something like the New York Stock Exchange but there are many other sources to find the cash you need for growth. I’ve worked for private investor groups looking for business investments and for larger venture capital firms that placed tens of millions in companies.
Most likely, if you’re the size of company that is going to raise a couple of million or more from equity financing, you know what sources are available. Let’s instead look at the market for smaller businesses.
- Friends, family and business customers can be a ready source for equity financing. This group already knows you and has a level of trust that will make converting them to investors easier. The disadvantage is that you might not be able to raise as much unless you have a large network or a rich uncle.
- Similar businesses can also be a good source for investors and bring the added benefit of investors with relevant business experience. You won’t want to approach direct competitors, but owners of related businesses will benefit by diversifying their wealth outside their own business.
- Local investor groups are where you start seeing the largest investments and other benefits of equity financing. These groups can invest hundreds of thousands and act as an advisory board to help guide and grow your business.
- Angel investor groups are one-step above local groups of smaller investors. Angels will be looking for companies that need $500K or more and with the potential to someday sell shares through an IPO.
How to Raise Equity Financing for a Small Business
You’ll need to incorporate your business before you can raise equity financing. This sets it up as a distinct legal enterprise separate from yourself and lets you sell pieces off as shares. You’ll include how many total shares are issued and what kind of voting rights each have within the corporate documents.
You’ll also need to name a board of directors to help look after shareholder interests. Management can fill a few of these seats but there should be others filled by people independent from you and your family.
Raising equity financing through your own personal network and business contacts is as simple as creating a contract for sale of the shares. The investors will be registered as part owners of the company and you’ll collect the funding. It’s important that you lay out a few rules in the contract though:
- Do investors get full pro-rata voting rights according to their shares and when is the annual meeting?
- How often will financial results be reported?
- Who will decide how much of profits are returned to shareholders and when?
- What is the process for valuing the shares and when can investors sell their ownership?
- What will the funding be used for and how long should it last?
Local investor groups will want to see more analysis of the business and potential for growth. You may need to bring in a finance person to write up financial statements and projections but it’s all worth it for the size of funding at this level.
Start small with equity financing, maybe selling 15% or less of the business, to investors that can bring experience as well as funding. Even a small business will grow dramatically with a little more funding and the insight investors can bring.