Navigating the business world as a new business owner can be confusing and overwhelming. There are so many terms and acronyms you don’t know about. One important term that you need to know about is equity. So here’s everything you need to know about equity in business:
What Is Equity?
Equity can mean a lot of different things, depending on the context. At the most fundamental level, equity measures the value of ownership. It can measure the value of an entire business, the value of a single stock issued by a business, inventory owned by a business, or ownership interest in a company through stock.
For this article’s purposes, we will be focusing on equity as an ownership interest in a company — or shareholder equity.
Shareholders vs. Equity Holders
The odds are that you’ve heard “shareholder” and “equity holder” thrown around without actually knowing what they mean. At first glance, they look the same! However, there are some key differences that you should know about.
For starters, shareholders own shares of stock in a company. Each stock represents a proportional ownership interest. For instance, say a company has 100,000 outstanding shares, and someone buys 1,000 of them. That person would then have a 1% ownership interest in the company.
Stock can either be publicly sold or privately placed. Most businesses start private but “go public” to raise capital and increase liquidity. They then list their stock for a certain price on a stock exchange through an initial public offering or IPO. From there, anyone can buy stock and be considered a shareholder.
This type of stock is referred to as common stock since it’s traded on major stock exchanges, and the price and dividends fluctuate over time depending on market conditions. Preferred stock, on the other hand, represents an equity interest that pays regular dividends.
Now that you know all about shares and shareholders let’s move on to equity and equity holders. Some businesses, especially smaller ones, do not have shares. Instead, they just have stakes of equity.
For example, in a sole proprietorship, a single person owns a 100% equity stake in the business — meaning that they control all business decisions and benefit from all profits. Another example is a partnership wherein multiple people work together in a business — each with equal equity. For example, there is a partnership with four people so that each individual owns a 25% equity stake in the business.
There are other ways to get equity, however. For example, individuals can invest in companies in exchange for an equity stake in the said business. This is referred to as equity financing.
What Is Equity Financing?
Equity financing involves a business owner giving up a percentage of their equity in exchange for funding from another individual or organization. The business owner does not have to pay regular payments to the investor or pay any interest with equity financing since it’s not technically a loan. Instead, the investor now has a say in business operations and shares profits based on their equity.
What Are the Different Types of Equity Financing?
There are three different types of equity financing you may want to consider: angel investors, venture capitalists, and equity crowdfunding. Here’s what you need to know about each type:
Angel Investors
Angel investors are individuals with deep pockets that provide funding to startups in exchange for equity in the business. This means they have a say over business decisions and split any profits based on the percent equity they control. Angel investors can be great business partners since they usually have substantial business experience to share with you to help grow the business.
Venture Capitalists
Venture capitalists are either individuals or larger organizations that provide substantial amounts of funding to more established startups. Venture capitalists are generally willing to take big risks to earn big returns. Like angel investors, venture capitalists also receive equity in the business in exchange for funding. Also, like angel investors, venture capitalists can be valuable business partners with great experience and connections.
Equity Crowdfunding
Equity crowdfunding involves using an online crowdfunding platform to sell off small shares of a startup in exchange for funding. Unlike angel investors or venture capitalists, those involved in crowdfunding don’t have to provide large amounts of money. Instead, individuals can contribute just a few dollars to receive a few shares. With enough contributions, startups can earn enough money to get their operations off the ground.
Should You Pursue Equity Financing?
While equity financing might seem like a great funding solution, it’s important to remember that it’s not free money. As a result, you need to consider using equity financing to fund your business carefully. Here are some things that you should consider before you agree to work with a venture capitalist or an angel investor:
- Equity financing may seem like a great deal right now since you’re getting money with no actual debt or repayment schedule, but it’s important to consider what this would mean for you down the road. For starters, you would no longer have complete control over your business. Furthermore, you would have to split profits with these investors based on their equity.
- On the other hand, if you don’t mind giving up some equity and control and want an experienced business partner to help guide you through your business journey, then equity financing might work for you.
- Equity financing doesn’t come with strict lending requirements or lengthy application processes like debt financing does. As a result, brand new businesses can secure equity financing, whereas they struggle to secure debt financing from traditional lenders.
How to Secure Equity Financing?
If you have decided that equity financing is right for you, now it’s time to make it happen! Unfortunately, securing equity financing isn’t always easy, but you can make it happen with the right amount of effort and a strategic approach.
First of all, you need to decide which type of equity financing you’re interested in, as your approach will vary based on whether you’re looking for angel investors, venture capitalists, or crowdfunding opportunities.
If you’re looking for angel investors, here are some resources to check out:
- Angel Capital Association
- Alliance of Angels
- AngelList
- Angel Investment Network
If you’re looking for venture capitalists, here are some resources to check out:
- National Venture Capital Association
- The Funded
- Venture Beat
- MicroVentures
If you’re looking for crowdfunding opportunities, here are some platforms to check out:
- Kickstarter
- Indiegogo
- CircleUp
- LendingClub
With these resources in mind, it’s time to start building your pitch! Tons of people compete for funding on these platforms, so you need to set yourself apart with the best presentation! Here’s how to make it happen:
- Tell the story of your business. Start off your pitch with an interesting story to get potential investors hooked and wanting to learn more. Talk about how you came up with the idea, where you come from, and your background.
- Talk about a problem, how you solve it, and what makes you different. Identify the problem that your product or service is solving — but don’t just stop there! Expand on what makes your business different from the competition.
- Talk about the industry and potential growth. Talk about how much the industry is worth and how much it’s growing. Investors will feel more confident investing in a booming industry that’s worth billions.
- Do a valuation. Investors will want to know how much your company is worth. For this reason, you need to come into the pitch with a well-researched and realistic valuation of your company. While it may be tempting to overvalue your company, many investors are turned off by this.
- Incorporate even more numbers related to your business. Investors are numbers people, and they want to see data to back up your claims. Come prepared with all sorts of financial data as it relates to your business, including revenue, debts, sales, growth, etc.
- Make an ask. Ask the investor for a specific amount of money — and tell them how much equity they’d receive in return. Be prepared to negotiate with them. Also, be sure to describe how you would use the funds to grow your business. For instance, you might need the money to finance your inventory, expand into ecommerce, invest in marketing efforts, etc.
Wrap Up on Equity in Business
If this leads you to pursue equity financing — great! However, if it leads you in the other direction toward debt financing, that’s fine too.
You have to make the best decisions for your business. If you need help making any of these tough decisions, feel free to reach out to D2C business expert Greg Gillman.
Sources:
Equity Definition: Formula, Calculation, & Examples | Investopedia
Equity: What Is It? | The Balance Small Business
What Is the Difference Between a Shareholder vs. an Equity Holder? | Fool.com
