Equity financing: not just for tech startups

Whether it’s the latest IPO or a hot new startup looking for funding, equity financing is often covered in the news. While it’s widely talked about, it isn’t the only way to raise capital for your business.

‍

Several factors go into deciding how to fund your operations, including your expansion plans and tolerance for splitting ownership of your company.

‍

In this article, we'll discuss how equity financing works, how to get it, and give you pros and cons to determine if equity financing is a good idea for your business.

What is equity financing?

Equity financing is when a business owner trades a piece of company ownership (called equity) for funding. A business may undergo several rounds of equity financing throughout its lifespan, starting from the very beginning and going to expansion, acquisition, and beyond. 

‍

This type of financing differs from other methods of raising capital in two big ways:

1. There is no expectation of repayment: Perhaps the most appealing part of equity financing is that it's not a loan. Rather, an investor buys a share of your business. You get to keep the money and they get to keep their percentage of the company.
2. You give up ownership of a part of your company: While you aren’t taking on debt with equity financing, you are giving up a piece of your company. This is often expressed in percentages and depends on the agreement you make with the investor. For example, you might agree to trade 5% of your company for a $100k investment.

‍

Equity financing is sometimes referred to as an “equity finance loan.” As you can see from the explanation above, this is a misnomer because loans require repayment and do not require you to give up ownership.

How does equity financing work?

Because equity investors don’t earn money unless the company does well, raising capital through this approach involves proving that your business plan is sustainable and scalable.

‍

Investors often have a goal of how much ROI they’d like to see—this might be anywhere from 30% or less to doubling or tripling their initial investment. They will be looking to you to provide them with reasons why your business is a valuable investment.

‍

Most often, this means creating a pitch deck that clearly explains the problem your business solves, why your solution is unique and how you plan to make and keep the business profitable long term.

‍

That said, there is no set process for raising capital through equity financing and the journey can look radically different from business to business.

‍

Some business owners prefer going through a structured route, such as applying to pitch competitions or well-known investment groups and accelerators. The limitation here is that these tend to be extremely competitive and may have requirements such as a specific industry, minimum annual revenue or affiliation with a university.

‍

On the other side, informal pitching happens all of the time. It’s possible to meet investors at events, online through platforms like Linkedin and Clubhouse, or through your local chamber of commerce. With this approach, the challenge is devoting enough time to networking to get your foot in the door.

Advantages and disadvantages of equity financing

Like all methods of financing, equity financing comes with pros and cons. Deciding whether equity financing is for you depends on your priorities when it comes to maintaining equity and fundraising.

‍

Even if equity financing isn’t the best choice at this moment, it may be a good fit in the future or in conjunction with other financing options. In short, it’s worth it to understand the ins-and-outs of equity financing to make a plan that works for you and your business.

Pro: Broader access to resources to help your business

‍

Equity financing often comes with access to broader networks and resources, in addition to funding. Investors have a vested interest in seeing your company succeed, and may offer their experience or connections to help you get to where you need to be.

‍

This type of financing is generally available to anyone, regardless of creditworthiness, revenue, or time in the business. In some ways, this means the barriers are lower than with other methods of financing. But because equity financing often depends on who you know, it can still be a challenging way to acquire funds.

Pro: No credit considerations

Perhaps the biggest pro to equity financing is that it doesn’t affect your credit. This type of financing is agreed upon with the individual investor, rather than moderated through banks. This means there are no APYs or credit checks to worry about.

Con: Dilution of equity

One of the biggest cons is the dilution of equity. Dilution in finance refers to the decreasing value of a single share of a company when new shares are issued. Think of it like this: if a company is worth $100 and is split between two people in equal parts, each part is worth $50. But if it’s split between 4 people the overall valuation doesn’t change but now each share is worth only $25.

‍

Since you must sell shares of your company to get equity financing, using this approach often dilutes the price of individual shares in the short term. Generally speaking, the goal is to use the funding to increase the overall value of the company to recoup the price per share.

Con: Expectations from shareholders

Another big con is that once you have active investors, they will want to influence big business decisions. Sometimes this is great. A pro to equity financing is that investors bring their knowledge and network to the table.

‍

But this might not be as rosy when shareholders are putting pressure on you to make decisions that go against what the owners think is best. Remember, the more shareholders you have at the table, the more people there are to appease.

Different types of equity financing

Not all equity financing is created equal. There isn’t a set standard or rules for how to trade your small business equity for funding, so you can get creative with how you find lenders and where to pitch your business.

Angel investors

Angel investors are wealthy individuals looking to grow their wealth by buying shares in promising companies. The term “angel” comes from the fact that they often provide funding for risky ventures that would otherwise not have access to funding.

IPOs

Initial public offerings (IPOs) are when a company’s stock becomes available to the public through the stock market. Doing this requires a lot of time and paperwork, and the outcome is usually quite risky. This is best left to companies that have enough brand recognition to warrant trust from the general public.

Venture capital

Venture capital firms are organizations that receive funding from investors and then invest in a portfolio of companies. Venture capitalists typically have formalized applications and processes for acquiring funding. It may be worth it to look for local VC firms or firms that specialize in your specific industry to give you a better chance of succeeding with this type of organization.

Crowd investing

Crowd investing or investment crowdfunding is a relatively new way to raise capital. Instead of looking for a few big investments, you look for relatively small investments from a large number of people. In exchange for this, they are promised future shares or partial shares of your company. This can be done on platforms like SeedInvest or FundersClub.

Friends and family

Entrepreneurs oftentimes have to get crafty, and depending on your circumstances, asking your family and friends to support your business can be one way to raise capital as an early-stage business. This can be framed as equity financing if they are willing to accept a portion of the business in return for the investment. It could also be debt financing if they expect to be repaid.

Equity financing vs. debt financing

If you’re hesitant about equity financing, there’s good news: it’s not the only option. You can access capital exclusively through debt financing or mix-and-match financing options to create a plan that works for your business.

‍

Debt financing refers to acquiring capital via business credit cards or bank loans. It differs from equity financing in a few ways:

1. Debt financing lets you keep ownership. Unlike equity financing, where you trade a percentage of your stake in your company for capital, strategically using debt lets you keep your share of the company. Fewer shareholders also means you get to call the shots without answering to external pressure.
2. Repayments are expected. Whereas equity investors make money when the company makes money, institutions that extend credit charge interest on debt. You are expected to repay the loan amount plus interest, just like any other loan.
3. There are formalized processes. Equity financing quickly becomes a game of “who you know.” On the other hand, debt financing has standard procedures and anyone can apply.

‍

There are pros and cons to both financing methods. To weigh them, consider questions like: What do you want to accomplish in the near future? How much time are you willing to wait? What is your tolerance for debt vs. letting go of ownership? All of these play a role in creating a sustainable financial plan.

‍

It’s also worth noting that you don’t have to stick to one type of financing. Many companies use a combination of debt and equity throughout different phases of growth.

‍

For example, you could raise a certain amount of money to start your business by asking your friends and family to sponsor your idea. Then, once you’ve built up several months of revenue, you apply for a corporate card to expand your business. After that, you could consider selling equity for increased cash flow and further expansion.

Equity financing as a part of an overall financing strategy

As mentioned above, the balance of debt financing and equity financing depends on your goals, timeline and desire to maintain ownership. Finding a strategy that works for your business fuels growth and gets your cash flow to where you want it to be.

‍

Don’t be afraid to mix-and-match to maximize the amount of funding you receive at each stage. It’s possible that taking out debt earlier in your timeline allows you to make your shares more valuable, allowing you to raise more capital later on. 

Finance business-critical expenses with commerce sales-based underwriting

Ramp makes securing credit more accessible with an innovative approach to underwriting.

‍

Traditional institutions look for several years of business operations, audited financials, and high minimum bank balances. Many also require a founder guarantee, which makes owners personally liable for business debt.

‍

Ramp’s commerce sales-based underwriting connects to data from Shopify, Amazon Business, Stripe, and other payment platforms to evaluate business health based on streaming sales data. This means high-growth businesses can access credit limits up to 30x higher than traditional financial institutions.

How Ramp can help manage your finances after securing working capital

If you’re looking to prove your business model to potential investors, applying for credit with Ramp is a great first step. Securing funding becomes easier for two reasons:

Building credit

When you build business credit, you signal to banks that your business generates enough money to cover your debts. Starting with a platform like Ramp allows you to increase your creditworthiness without having to wait for years.

Expense management

Beyond extending business credit, Ramp also helps businesses stay financially viable thanks to a full-suite of finance automation tools. With AI-powered features like automatic bill pay, spending alerts and bookkeeping that syncs to your platforms of choice, Ramp makes it easy to keep tabs on your corporate finances—and makes tailored suggestions to minimize expenses and increase cash flow.

Wherever you are in your journey, Ramp is prepared to help you manage your finances and get your business to the next step.