The potential sources of equity capital begin with your family and extend to Wall Street with numerous stops en route. Most businesses will at sometime need the equity financing that only outside investors can provide.
What do we really mean by the term equity financing? What are some of the potential sources of equity financing? And what are the the interests of the potential equity investors?
To begin with, equity financing is different from debt financing in that the equity investor gets a real ownership position in your business. Equity capital is at risk and has no guaranteed return. With conventional debt financing there is a pre-arranged payback schedule. An equity investor, on the other hand, is entitled to share with you on a pro-rata basis in the profits and the future worth of the business. One of the most important decisions for the business owner about to accept equity financing is the amount of ownership that the new investors will receive.
Before approaching any outside investors prepare a quality business plan. I can hear the groans already. Believe me, I have financed businesses with banks, government grants, private investors and public stock offerings. A well thought out business plan accomplishes two objectives. First, it allows potential investors to make a professional and objective evaluation of your business. Secondly, and most importantly, it forces you into a disciplined review of the entire scope of your new enterprise or expansion. Do it and do it right.
A convenient way to review the potential sources of equity financing is by the degree of active involvement the investor will have with your business. The most immediate and active source for investment capital would be a partner. Partnerships can be a duel edged sword. A carefully chosen partner can be a giant stepping stone to success. In addition to the doubling of your capital base, you will spread the risks, multiple your contacts, distribute the work load and gain additional perspectives. A flawed partnership can inflict both economic and physcological damage. Always have a clear-cut, detailed, written partnership agreement. A formal legal document is a must. If it would be awkward to discuss such a formal understanding with a potential partner, after all it might be a long time friend, don’t become business partners.
Informal investors, those individuals that generally invest from ten to fifty thousand dollars of their own funds, form what I consider to be the great untapped source for equity financing. The informal investor likes to take an active role in following his investment and enjoys the association with the business owner that he is supporting. The informal investor has surplus funds as a result of a successful career that is in progress or has ended with a well deserved retirement. In either case, the informal investor, while interested in the business, is not interested in managing the business or overly interfering with management. However, because of the informal investors success in other areas, they can often be an excellent sounding board when outside advice is needed.
Informal investors can be found most anywhere. Inquiries to your professional advisors will put you on the right trail. Be patient and remember, that as always, the investor is investing in you and shouldn’t be rushed.
Venture capital funds have become a primary source of funding for new and growing businesses. The investment characteristics that are important to venture capitalists are applicable in varying extents with all equity investors. The M.I.T. Enterprise Forum states four characteristics that make a business attractive to venture funds. First, evidence that there is a marketplace acceptance of the company’s product. Secondly, a means by which the investors can get their investment out of the company at some future date with a satisfactory return on their investment. Thirdly, a clearly defined focus and concentration of activities. And finally, the existence of a proprietary product or service.
Private placements, the limited sale of unregistered securities to sophisticated investors, and public stock offerings are two additional means of raising large sums of equity financing. While both sources raise substantial sums without involving individually active investors, they do become complex in the reporting and regulatory requirements that are imposed on your business.
From your neighborhood partner to Wall Street and back again. Family and friends as investors often form the least demanding, most readily available source of equity financing. They know you and want to see you succeed. They often only ask that their funds be returned when you can make other arrangements. They are the most passive of investors in that they have no interest in meddling in your business. If you have family and friends that can help, don’t be afraid to ask. We all need help at sometime. Try to keep the relationship business like and give them more than they ask in return for their support. Keep them informed of your progress and if your are successful, in addition to showing your appreciation, give them a fair return on their investment.
If you are fortunate enough to be able to provide all the equity financing your business needs to get started, do it yourself. If your business is sufficiently profitable to generate internally all the cash you need for growth, go it alone. However, if you need equity financing , take the time to examine all the alternatives available because “It’s Your Business”.