Equity Financing: Sharing the Spoils

Is scarcity of funds obstructing your venture? Are you looking for ways to finance your new business but dread the thought of monthly loan installments? If you said yes to the above, equity financing is what your business needs. Equity financing helps you raise funds without having to shoulder the burden of repayment.

It ain’t money for nothing. Sure, equity financing is not a loan, but it isn’t a gift either! When you raise equity funds, you part with an ownership interest in your company. This ownership takes the form of common stock or preferred stock. If the company makes a profit, investors receive a part of it in the form of dividend. Apart from taking a stake in the company, investors may also participate on the company’s board of directors and take an active role in managing the business. Bet that’s stuck in your throat!

While informal sources such as family and friends can provide equity financing, the most important source of professional equity funding are venture capitalists. These are deep-pocketed financial wizards in the business of investing in new or riskier businesses in exchange for very large returns.

So, what do equity investors look for?

Growth potential: Equity investors are usually aiming for the stars, and their only concern is how soon there can get there. That is why companies on a high growth path, capable of delivering solid returns on investment are more likely to get financing.

Exit strategy: Venture capitalists in particular, look for companies that have a clear exit strategy. They don’t want to hang around till it’s time to walk into the sunset. Five to seven years is all they’ll give you, and in that time they’ll expect to have trebled their investment at a minimum. If they can’t find a way of pulling out by way of a strategic sale, they won’t play ball.

Management quality: Since equity financing is all about investors climbing aboard, you can bet they’ll want to know who is captain of the ship. They pay more attention to the capabilities of the management team than anything else.

While interest payments won’t loom large over your head with equity financing, it will make a different set of demands on your business. Weigh the pros and cons before you take a decision.

The best part is that you pay back your investors only if the business does well. That way, you’re not the only one bearing financial risk. The right venture capitalist can bring in valuable skills, experience, contacts and assist you with strategy and decision making. What’s more, if the business does well, you are likely to secure further equity financing from existing investors.

On the flip side, you will have to accept a dilution in your shareholding. Also, some investors can be very high maintenance – so be prepared to be answerable to a bunch of hawks! This is the hardest for independent minded entrepreneurs.

Once you have decided to go in for equity financing, get cracking on your business plan. Talk to your financial and legal advisers before you reach out to potential investors. Be clear in your mind on the following:

a) How much funding is needed and for what purpose?

b) For how long would you need these funds?

c) How much stake are you are willing to part with?

It’s best to answer these questions in your business plan and tailor the information according to the specific investors you plan to approach. Equity financing can be a boon for new entrepreneurs if it is used appropriately with targeted goals. Do refer to books like “Financing Your Small Business” and “How to Raise Early Stage Private Equity Financing” from amazon.com and “Financing Your Small Business” from paloalto.com to find out how it can work for you.