Debt and equity financing are pivotal aspects of funding. Debt and equity financing are both ways that businesses can raise capital to fund their operations. Debt financing involves borrowing money from lenders, such as banks, financial institutions, or bondholders, with the expectation of repayment with interest over a fixed period.
Equity financing, in contrast, is the process of raising capital by selling shares of ownership in a company. Equity funding for startups provides access to funds without taking on debt financing. As a founder, understanding private equity financing and the types of equity financing is indispensable to raising equity funding for startups. This article explains the premise of equity financing.
Types of Equity Financing
Angel Investments – Angel investing refers to the process of HNWIs, known as angels, investing their own funds to provide private equity financing. Typically, they look to invest in innovative and high-growth potential startups and often help with their expertise and network connections.
Venture Capital – Venture capital (VC) is one of the types of equity financing that involves funding startups that have high growth potential. They like to invest in disruptive technologies.
Crowdfunding – Crowdfunding is securing small amounts of capital from a large number of people to fund a business. The 4 different ways to raise money via crowdfunding are as follows:
- Peer-to-peer lending
- Rewards-based Crowdfunding
- Equity Crowdfunding
Initial Public Offering (IPO) – IPO is the process by which a private firm goes public by offering its shares to the general public on a stock exchange for the first time. The company issues shares to the general public to raise finance and helps investors turn a profit.
Advantages and Disadvantages of Equity Financing
No obligation to repay: Since there’s no debt involved, there’s nothing to be repaid. This is a huge advantage for small businesses.
Access to expert advice and mentorship: Having a mentor can be unbelievably helpful since they provide guidance on deals, and terms, and can be a huge motivation during low times. They also provide network connections. Know who your investor is right off the bat.
Ability to attract top talent: This build on the last point, that network connections also help hire personnel which is a bonus for an entrepreneur with less sophisticated connections.
Increased credibility: VC funding or Angel investments are looked at as a positive sign for any business. It validates your presence in the market.
Loss of control: Since you’re giving equity shares in return for an investment, there is a particular portion of control you forgo. Make sure you have air-tight term sheets.
Dilution of ownership: Again, giving away shares is also giving away a part of your ownership (not just control) of the business.
Shareholder expectations: This one can be hard to manage especially when there are massive expectations put on you that you couldn’t meet. It creates tension and unease amongst everyone in the business.
A time-consuming and complex process: There are multiple things to do when it comes to securing equity funding: due diligence, finding a valuation, documentation, compliance, and maintaining investor relations. Some would argue that it could take your focus away from the actual work of the business.
Preparing for Equity Financing
Use these pointers to help you jumpstart your quest to secure equity financing:
- Develop a business plan
- Understand your company’s valuation
- Prepare financial statements
- Assemble a strong team
- Conduct due diligence
Equity Financing Term Sheet
What’s a term sheet?
A term sheet is a document outlining the terms and conditions of a proposed business deal between two parties. The term sheet includes details such as the proposed price, amount and type of funding, the ownership structure, the rights and responsibilities of each party, and any special provisions or conditions.
Key terms and provisions you should know:
- Consideration: what each party will receive in exchange for their contribution to the agreement, such as cash, equity, or other assets.
- Payment terms: the amount and timing of any payments to be made.
- Representations and Warranties: Each party’s representations and warranties are statements about the truthfulness and accuracy of information related to the agreement.
- Conditions precedent: The conditions such as regulatory approval or the completion of due diligence.
- Termination: The circumstances under which either party can terminate the agreement before the end of the term.
- Confidentiality: The confidentiality provisions, outline how confidential information will be protected.
- Dispute resolution: stating the process for resolving any disputes that could arise between parties.
- Indemnification: The determining of which party will be responsible for any losses, damages, or liabilities that may occur
Negotiating the term sheet
First, identify your priorities and objectives and communicate them to the other party clearly. Do your research and be up-to-date about market standards and industry norms. While negotiating, maintain and be cooperative and respectful. Lastly, be prepared to walk away from the deal if you feel like the terms aren’t what you really want. A lot of entrepreneurs sign on horribly unfair term sheets in the lure of securing financing. Know what works for you, and you’ll have a much easier time.
Use the pointers to remind you about what to consider post-financing:
- Maintain relationships with investors
- Governance and reporting: Follow the legal and accounting procedures applicable as per your country
- Shareholder agreements: Includes voting rights, management structure, share transfer restrictions, dividend policy, and dispute resolutions
- Exit strategies: Post-financing exit strategies are plans laid down by investors and entrepreneurs to exit an investment in a company after a successful financing round. It could include an IPO, acquisition, management buyout, or secondary market sale (when investors sell their shares to other investors instead of waiting for a liquidity event).
In A Nutshell
So to sum up, equity financing is beneficial since there’s no repayment of the debt, and you have access to mentorship and several network connections that can help you hire top talent while helping you create a better impression of your business. The cons however are that you would have to be giving up ownership and control and having to constantly keep an eye on whether you’re meeting investor targets.
There is another option though; debt-equity finance. Debt-equity finance is when a company raises capital by issuing a mixture of debt and equity securities. The company can issue debt securities such as bonds, notes, or loans to borrow money from investors, while simultaneously issuing equity securities such as stocks. Although flexible and cost-effective, it requires vigilant management of financial risks.
If you’re wondering about the best way to raise funds, give the pros at Marquee Equity a call at +1-213-600-7272 and take your business to new heights.
We optimize & accelerate growth for already great products.
Venture Capital Funding: What You Need to Know
Venture Capital Funding is a dynamic financing avenue for startups, involving investors providing capital in exchange for equity. Key considerations include a robust business plan, team expertise, and market potential. The funding process spans various stages, from seed to Series funding, with exits through IPOs or acquisitions. Understanding this landscape is crucial for aspiring entrepreneurs.