With equity financing the pros and cons are reversed. Even if you manage to satisfy the securities regulators, don’t forget the gut check. You can only sell equity in your firm to 35 or fewer unaccredited investors. We really, REALLY recommend that you enlist legal counsel whenever you’re negotiating an equity arrangement. If one day you become wildly successful and the profits start rolling in, you really don’t want to regret giving up 50% ownership of your business in exchange for $500 to buy an espresso machine, even if you do need the coffee to work long hours. While you may first turn to friends and family for a capital infusion, it’s important to understand that you can’t sell equity in your company to just anyone. As long as you are making your payments on time, they will pretty much stay out of your way. The bank or investor does not “own” any portion of your business and they don’t have any say in your day-to-day operations. You may have used a similar model to pay for college, your first car, or that Xbox 360 you just HAD to have when you were 15. Because the value of startup incubators is so great, acceptance into them is typically VERY competitive across all industries. You can join Kickstarter online, post information about your business plan, then wait and see if you get any bites from investors. Interest –The most significant drawback of debt financing is that you have to repay the bank or investor with interest. While it can be tempting to jump at the first offer you get (“this person is giving me cold hard cash – I’ll take it!”) the ins and outs of equity contracts can be complicated, and it’s important that you have an experienced professional looking out for your best interests, both today and down the road. Lean Startup Plan: Which Is Best When Starting Your New Business. The cost of preparing these documents can easily run $10,000 or more. In selling equity, you and your business must exercise care so as to prevent giving control of the business to investors and to ensure compliance with federal and state regulations affecting such sales. Recently I was trying to help a client extricate himself from a mess he had created by taking money for his business from the wrong people. It wasn’t long before he found them making outrageous demands and even threatening shareholder litigation. Over the past year, websites like Kickstarter have become so popular that even celebrities are using them to fund TV shows, movies, and other personal projects. Banks are wary of startups because many fail. In selling equity, you and your business must exercise care so as to prevent giving control of the business to investors and to ensure compliance with federal and state regulations affecting such sales.
No Monthly Payments - You probably won’t need to make monthly payments until you make a profit – which keeps more cash in your pocket while you get things up and running. Strict Lending Requirements – Debt financing can be difficult to get, especially for a startup company. If you are able to secure a loan, you’ll need to start paying it back right away, which immediately reduces the cash you have to work with on a monthly basis. The Challenges of Raising Money with Equity Financing. For example, if you think you need a BMW to meet with clients, and they think you need a used Honda – you’ll be in the Honda. Share profit. Generally, accredited investors have the financial resources and knowledge to rationally make business investments. So let’s say you decide debt financing isn’t for you — and you want to grow to your business with equity.
But whether you raise money from one or 20 unaccredited investors, you will need audited financials and a private placement memorandum. Is the equity appropriate for your position? When you first meet with a potential investor, they will likely present you with a “term sheet,” which is just a fancy way of saying “this is how much I’ll give you in exchange for this percentage of your future profits.” A term sheet might also outline how much say the investor has in your business decisions, and what they will require from you on a monthly or quarterly basis to document your progress. When it comes to getting your small business or startup off the ground you have two options for financing (three if you count the lottery!
Don’t worry. Don’t skip this step! If you think your business could benefit from more than just cash, but also a little business advice or mentorship, you might consider a startup incubator. Companies that are too highly leveraged (that have large amounts of debt as compared to equity) often find it difficult to grow because of the high cost of servicing the debt. And one of the crucial distinctions is the difference between accredited and unaccredited investors. What online fundraising sites can be used for projects?
While an IPO (initial public offering) on the stock market IS one way to earn equity, it’s typically not feasible (or recommended) for a small startup business. Your investors will expect – and deserve – a piece of your profits. As the deal proceeded, his gut told him there was going to be trouble, but he needed the cash and let them buy in anyway. No Interest Payments - You do not need to pay your investors interest, although you will owe them some portion of your profits down the road. Two ways to make your business seem less risky: Enter your email to download this guide as a printable PDF, 3 Types of Angel Investors and How to Pick the Right One, The Best Sites to Raise Money and Get Your Ideas Off the Ground, 8 Kickstarter Alternatives You Should Know About. Some of the most popular incubators today include Y Combinator, TechStars, 500 Startups, and Capital Factory, among many, many others. ): Company Ownership - Debt financing is pretty straightforward legally.
An accredited investor is someone who has $1 million in net worth, or in the last three years has earned at least $200,000 a year if he or she is single, or $300,000 a year if he or she is married. While equity investment may seem like “free money” (after all, you don’t repay it unless your business succeeds), in reality, turning even part ownership of your firm over to investors can make it the most expensive money you’ll ever take. High interest costs during difficult financial periods can increase the risk of insolvency. That means, for most young companies, the investor of choice is an accredited investor. One of the major benefits of investor networks are that they allow hundreds of people to make investments of varying amounts to your project – preventing you from being “owned” by one major investor. However, it could be a worthwhile... Loss of control. Still, it’s a good idea to share your business plan and financial information to help avert misunderstandings later.
Once you’ve located a good source of cash, you’ll need to negotiate a fair deal. An extremely popular network that you may have heard of is Kickstarter. The U.S. Securities and Exchange Commission figures if you have a significant net worth you don’t need to be protected like “widows and orphans.” Even if your unaccredited investors are family members or friends, you must provide these documents. (In fact, even if your parents are lending you the money, they are legally obligated to charge you interest for investments over 14,000, or else they will be required to pay a “gift tax.”). These incubators are sometimes specific to certain fields (technology or entertainment, for example), and others will accept applications for all types of ventures. Yea, yea, we know – lawyers are expensive.
Tax Advantaged - The interest you pay on debt financing is also tax deductible, and your loan payments are predictable from month to month (kind of like a car payment or mortgage payment).
Now, just like you wouldn’t blindly accept the first offer on that old Chevy you sold on Craigslist, you shouldn’t accept a term sheet right off the bat either. If your business doesn’t take off, you may be faced with liquidating (i.e. Resources for employees considering equity. Instead, your investors will likely come in the form of friends, family members, business contacts, and potentially angel investors or venture capitalists. Depending on who your investors are, and how their vision for the business aligns with yours – this can be no problem at all, or a major pain in the you-know-what. The Complete 35-Step Guide for Entrepreneurs Starting a Business, 16 Key Issues in Negotiating an Employment Severance Package, 10 Expert Social Media Tips to Help Your Small Business Succeed, 5 Steps to Building a Million-Dollar Business With No Employees. For the most part, if you can make your business appear less risky, you can often negotiate a better deal. When negotiating equity, your foremost concern should be maintaining control of your business. The Pros and Cons of Equity Financing. Academia.edu is a platform for academics to share research papers. more money for you, less ownership for them) it’s important to understand how investors think: Investors typically base their offers on the level of risk they perceive for the specific investment. With these investors there is far less documentation than there is with unaccredited investors. When you think of investors you probably picture Wall Street and the crazy, hectic, confusing and loud stock market. When it comes to getting your small business or startup off the ground you have two options for financing (three if you count the lottery! The irony is that it costs more to raise money from people who don’t have a lot of money than it does to raise money from rich people. Startup incubators are large companies that offer seed money, expert mentorship, supplies, and sometimes even office space in exchange for a share of company ownership (equity). What’s the next step? selling) personal assets such as your house, your car, your firstborn (just kidding) to pay back your loan. First, you’ve got to follow the money — that means locating and soliciting investors. Liability - In many cases, a bank will ask for personal collateral to back a loan, even if you have an LLC (limited liability corporation). Traditional Business Plan vs. A term sheet should be viewed as a starting point for the negotiation, NOT a final contract. You do not have to provide audited financials or a PPM to an accredited investor. Copyright © 2020 AllBusiness.com All Rights Reserved. Potential conflict. It also allows you to connect with investors across the country and around the world.
You must comply with federal securities regulations, even if your business is relatively small or young. His business was growing but had been experiencing growing pains, and he couldn’t borrow to take things to the next level. But trust us, they’re worth it. Angel investors (investors who support businesses they believe in, rather than businesses that promise the highest return on investment) and venture capitalists (your traditional “sharks”) can be located by word of mouth, and also through sophisticated investment networks. Giving Up Ownership – Equity investors own a portion of your business, and depending on your particular agreement, they may be able to have a say in your day-to-day operations, including how you spend the money that they’ve invested. But don’t let that stop you – if you believe in your idea, chances are you can convince someone else to believe in it too. No Liability – If the business doesn’t succeed, the investors are the ones who take the hit – not you or your family.
So he approached some potential investors about investing in the business. Depending upon the business entity the business uses, you may raise money by selling shares of stock, membership interests, or partnership interests. ): Debt financing is pretty simple.
To negotiate a better deal (i.e. 8 Reasons Startup Incubators are Better than Business School, The Pros and Cons of Startup Accelerators, Whether or not equity is right for your business, Types of equity compensation and vesting terms, How much equity you should offer your employee, Getting Paid in Equity: Help for Employees.