4 Types of Equity Financing

Equity Financing: The method of raising funds by selling company stock to investors. In return for the investment, the shareholders receive ownership interests in the company.

1. Friends and Family

Friends and family are the initial sources of capital for many startups. Although these investors are generally less sophisticated than angels, venture capitalists or private equity firms, it’s important to treat their investment as you would any equity investment. Follow regulations regarding issuing stock, maintaining corporate documents and more. Otherwise, you could be at risk of violating SEC regulations.

Best for:

  • Startups
  • Companies seeking relatively small amounts of capital

2. Angel Investors

Angel investors are wealthy individuals who invest their own money in early-stage small businesses, often in industries in which they have experience as entrepreneurs themselves. They typically make investments of $100,000 or less but may form angel groups to pool their investment capital and invest larger amounts. It adds up: In 2013, angels invested $24.8 billion in a total of 70,730 entrepreneurial businesses, the Center for Venture Research reports.

The right angel can really make a difference to your business. Angels often offer valuable advice, connections, and guidance in addition to capital. In return for their contributions, angels may want a voting seat on your company board and a say in major business decisions in addition to equity. However, they will often take a smaller stake than venture capital companies. According to the Center for Venture Research, in 2013 the average angel equity stake was 12.5%.

You may be able to find angel investors through your connections. Perhaps you personally know wealthy individuals who might invest in your business. There are also online portals where you can connect with angel investors and angel groups.

Best for:

  • Early-stage companies
  • Companies seeking $100,000 or less

3. Venture Capital

Angel investors are wealthy individuals who invest their own money in early-stage small businesses, often in industries Do you dream of finding a moneyed venture capital firm to invest millions in your business? Venture capital firms, which invest institutional capital in return for equity in businesses with rapid growth potential, have helped companies such as Facebook, LinkedIn, Zappos, eBay and Google grow from tiny startups to household name.

Venture capitalists invest large sums – an average of $7 million—and typically require a majority stake in the business in return. They will also expect a say in the management of the business and an exit strategy that provides a big payoff. When you add up the liquidity requirements and other investor rights that the venture capital firm receives, the effective cost of venture capital can exceed 70%. As the business owner, you may find yourself taking a lesser role in the company, or even being forced out as the VC’s share of the company grows. Make sure you’re comfortable with this possibility before you consider venture capital.

The average venture capital firm receives thousands of business plans each year but invests in fewer than a dozen. According to the National Venture Capital Association, between 2010 and 2013, only about 15,600 companies out of 6 million small businesses in the United States received venture capital financing. You’re more likely to get venture capital if your business is in the software, media/entertainment, information technology or biotech sectors. More than 65% of all investments in the last three years have gone to companies in those industries.

Best for:

  • Companies beyond the startup stage with potential for rapid growth and high returns
  • Companies that need large amounts of capital
  • Business owners who do not mind giving up equity and perhaps even control of their companies
  • Companies in IT, biotech, media and software

4. Private Equity

Private equity firms invest capital in privately held companies. Although they typically focus on bigger businesses, not small ones, some private equity firms take an interest in small businesses in their sector. Private equity companies differ from venture capitalists in that they seek mature or underperforming companies that they can invest in, improve and then sell at a profit. In most cases, this means that the owner will no longer be part of the business.

Best for:

  • Companies that are struggling
  • Business owners who want to exit their business