Raising equity is an appealing funding option for many startups.
You don't always have to take out loans to grow your business. Instead, you can raise equity, which allows you to finance deals by exchanging company ownership for capital. If you are considering this option, it is important to have a clear understanding of equity financing, its advantages over funding alternatives and how you can raise it.
What is equity financing?
Equity financing is when an investor provides capital in exchange for a stake in the business. An investor provides the capital needed for business growth, and the business gives the investor a proportionate number of shares in the company. Angel investors and venture capitalists are increasingly common sources of equity financing for startups. Additionally, you can seek equity financing from your friends, family or even an initial public offering (IPO).
Benefits of raising equity capital over other alternatives
Here are some reasons you may choose to raise equity capital rather than obtain other forms of funding, according to Bizfluent:
1. No loans to repay
Investors generally don't require you to repay the capital they give you in exchange for the stakes in your company. That's because your investors usually expect (or at least hope) that your company will grow significantly over time. If it does, your investors can later pursue a buyout that's worth far more than their initial investment.
2. No interest to pay
When you raise equity, there's no material exchange of cash, so there's no way for your equity provider to charge you interest.
3. More capital
Because there is no loan repayment involved with raising equity, you retain all of your current capital. You'll have capital coming in from your investors and your own ability to access capital, so raising equity is an effective, simple way to expand your capacity for obtaining the resources you need.
4. Quick access to cash
Entrepreneurs often have to choose between debt financing and equity financing when raising money. For fast cash access, equity financing is superior because the traditional lenders that offer most debt financing options may take days to weeks to process your application. Equity financing is often more personal, with fewer formalities and thus a quicker process for getting cash.
5. No limit on funding access
Sometimes, debt financing can cost so much to repay that you just don't have the room in your company budget to add more loans. This limits the number of loans you can take out. With equity financing, you theoretically have no limit on the number of times you can access funding. In fact, it's common for companies to raise equity in multiple rounds rather than in one fell swoop.
6. Diverse options
You can attract investors to your company with several types of equity. Try offering preferred stock, convertible stock, common shares and warrants. Different types of investors may prefer certain kinds of equity, so your investor options may be broader.
Three ways to raise equity for your business
If you want to try equity financing, you should take a methodical approach to finding investors. Don't just rush into it, asking everyone you know to invest in your company. Here are three ways to raise equity for your company:
1. Ask your friends and family first.
While it might be tactless to ask everybody you know whether they want to invest in your company, don't be afraid to ask friends and family who have expressed a clear interest in what you do. If you find friends or family who are interested, arrange their equity contributions just as you would work with professional investors: Present your business plan and budget forecast, and sign a contract.
2. Turn to private investors.
Another option is to raise equity through private investors. You are likely best served by being more formal with private investors than with family and friends. Walk yourself through the following four steps to maximize your chances of successfully raising capital through private investors:
Create a business plan. Just as you did when you sought equity financing from friends and family, create a business plan for private investors. Outline your company's products and services, detail your competition and market, present several marketing approaches, and forecast your budget and earnings.
Compile relevant past successes. Your company may be brand-new, but you still have some evidence to suggest that your business will succeed. Any past activities that demonstrate your ability to sell your new company's products and services can point to future business success. You should prioritize financial figures over other data, but it never hurts to supplement dollar signs with anecdotes.
Find your investors. While you have immediate access to most things you need to create a business plan and gather your past successes, you may face bigger challenges in reaching investors outside your friends and family. That said, there are plenty of websites designed to connect startups with investors, and you can turn to these platforms to build relationships and, ultimately, raise more equity.
- Set up meetings. Whether you choose to meet in person or via video chat, getting some face time with your investors can be crucial for sealing the deal. During this meeting, give more context to the documents you've presented. Prepare your responses to potential investor questions, and answer them clearly when they emerge in the meeting. Discuss the next steps before ending the conversation.
3. Go public.
During the early stages of raising equity, you'll turn to people who know you well and investors who have the professional know-how to assess your merit. This crowd may be limited (though not necessarily small). To raise equity with a potentially unlimited crowd, go public.
If you do choose to go public, the Corporate Finance Institute recommends taking the following steps:
Choose an investment bank. Going public requires you to find an investment bank that can advise you on your IPO and broker stock transactions between the public and your company. Choose a bank based on its reputation, industry expertise and any prior relationships you have.
Comply with regulations. Your investment bank will require you to take certain steps to comply with regulations for publicly traded companies. These steps can be time-consuming, but you shouldn't overlook them.
Know your stock price. To adequately raise equity from the public, you need to find a stock price that's both reasonable for buyers and high enough to meet your funding goals.
Stabilize your stocks. If your company's stocks are bought or sold in ways that result in an order imbalance, have your bank stabilize your stocks before you continue to raise public equity. Your bank will stabilize your stocks by buying them at or below your offering price.
- Begin competing in the market. After the IPO, you'll enter a transition to market competition. At this point, your bank can estimate your company's value. You can then adjust your stock prices to work toward your equity financing goals and get the cash your business needs to grow.
While raising equity through public offerings may prove profitable, going public may not be right for all companies. Use business.com's guides to Going Public or Staying Private and How to Assemble the Right Team Before Going Public to help you decide. Your equity financing options may differ based on your decision.