Truth 25. Equity funding
Equity funding is obtaining money from an investor. Investors are typically interested in businesses that plan to grow and can capture fairly large markets. These businesses normally have a unique business idea and a proven management team and are shooting to capture large markets. If your business fits this profile, and you’re willing to accept the hectic pace of activity that running a rapid growth business entails, seeking equity funding may be a good option for your business.
The primary advantage of equity funding is access to capital, which is the reason it’s often pursued by businesses that have high start-up costs. In addition, because investors become partial owners of the firms they invest in, they often try to help those firms by offering their expertise and assistance. The money received from investors also doesn’t have to be paid back. The investor receives a return on the investment through dividend payments and by selling the stock. The primary disadvantage of equity funding is that the firm’s owners relinquish part of their ownership interest and may lose some control.
There are two sources of equity funding: business angels and venture capitalists.
The primary advantage of equity funding is access to capital, which is the reason it’s often pursued by businesses that have high start-up costs.
Business angels
Business angels are individuals who directly invest their personal funds into start-ups. They generally invest between $10,000 and $500,000 in a single company and are looking for companies that have the potential to grow 30 to 40 percent per year (which is very aggressive) before they are acquired or go public.[1] Jeffrey Sohl, the director of the University of New Hampshire’s Center for Venture Research, estimates that only 10 percent to 15 percent of private companies meet that criterion.[2] The one exception that might help you get your foot in the door with an angel investor, if your business doesn’t meet the traditional criteria, is if the purpose of your business is aligned with a personal interest or passion of the investor. For instance, if you’re starting a company to make a safer car seat for infant children and meet an angel investor who has an intense interest in child safety products, you could capture the investor’s attention even if your firm isn’t capable of a 30 to 40 percent per year growth rate.
Most business angels remain fairly anonymous and are matched up with business owners through referrals. If you’re interested in pursuing angel funding, you should discretely work your network of acquaintances (bankers, lawyers, accountants, successful entrepreneurs) to see if anyone can make an appropriate introduction.
Venture capitalists
The second type of equity investor is venture capitalists. Venture capital firms are limited partnerships of money managers who raise money in “funds” to invest in start-ups and growing firms. Some of the better-known venture capital firms are Kleiner Perkins, Sequoia Capital, and Redpoint Ventures. Similar to business angels, venture capital firms look for a 30 to 40 percent annual return on their investments and a total return over the life of investments of 5 to 20 times the initial investments. The major difference between venture capital firms and business angels is that venture capital firms lend little money to start-ups (preferring to wait until a firm proves its product and market) and normally don’t invest less than $1 million in a single firm. As a result, venture capital funding is only practical for a small number of business start-ups.
The major difference between venture capital firms and business angels is that venture capital firms lend little money to start-ups and normally don’t invest less than $1 million in a single firm.