Equity financing is a method of small business finance that consists of gathering funds from investors to finance your business. Equity financing involves raising money by offering portions of your company, called shares, to investors. When a business owner uses equity financing, they are selling part of their ownership interest in their business. Below are five types of equity financing for start-up or growing company:
1. Initial Public Offering
This takes place when a company that has decided to “go public” offers up initial shares on a publicly-traded market such as the New York Stock Exchange. “Going public” is the term used to describe transitioning to a publicly-traded company. This type of funding requires developing the offering in compliance with the guidelines established by the Securities and Exchange Commission (SEC). The SEC requires that the IPO be registered and approved. If approved, the SEC gives the business a listing date. The listing date is when the shares will become available on the market they are going to be traded on. Going public is usually reserved for small businesses that are regional or national in nature.
2. Small Busines Investment
The Small Business Administration licenses regulates a program called small Businesses Investment Companies that provides venture capital financing. Venture capital firms pool investors’ money in order to invest in start-up, possibly high-risk business firms. These investors may be wealthy individuals, private pension funds, investment companies, and others.
Venture capital financing is a competitive method of funding since a venture capital firm may have any number of firms and projects competing for money at a given point in time. The underwriting requirements are considered to be less stringent than those for an IPO. This makes it an attractive opportunity for smaller businesses without the need for an extensive IPO process.
3. Royalty Funding
Royalty financing, or revenue-based financing, is an equity investment in future sales of a product. Royalty financing differs from angel investors and venture capitalists because you have to be making sales before approval. Investors will expect to begin receiving payments immediately as a result of the agreements made with the lender. Royalty financers provide upfront cash for business expenses in return for a percentage of the revenue received from the product.
4. Equity Crowdfunding
This is the act of is selling shares of your company to the crowd as opposed to using a platform where you pre-sale your product to the crowd. The owners of a privately-held business raise money through selling a portion of their ownership interest, or equity, to investors in the crowd in this way. There is less than half the number of publicly-traded companies there were in the 1990s. Through equity crowdfunding, companies can remain private but raise funds from the public.
5. Venture Capital
This type of financing provide funding in exchange for ownership, or shares, of your business. Venture capitalists are looking for high rates of return when they invest their money in a start-up small business. They usually have many competing businesses from which to choose. Unlike angel investors, venture capital firms don’t use personal funds for investing in startups. These firms consist of a group of professional investors who pool money to invest in start-ups or growing firms. Venture capital firms may also want a seat on your board of directors. Some venture capitalists see a board seat as a form of managing an investment. Many venture capital firms have transitioned to a mentoring approach to assist with investment growth.