Equity Options for Business

Equity Options for Business

From the U.S. Small Business Administration

Equity Financing

Most small or growth-stage businesses use equity financing in a limited way. As with debt financing, most of the time additional equity comes from non-professional investors such as friends, relatives, employees, customers or industry colleagues.

However, the most common source of professional equity funding is that group of investors known as venture capitalists.

Venture capitalists are institutional risk takers and may be groups of wealthy individuals, government-assisted sources or major financial institutions. Most specialize in one or a few closely related industries.

The high tech industry of California's Silicon Valley offers many shining examples of capitalist investing. While public perception of venture capitalists may be of deep-pocketed financial gurus looking for "that hot new business" in which to invest their money, in reality they most often prefer three-to-five-year old companies that offer the potential to become major regional or national concerns and return higher-than- average profits to their shareholders.

Venture capitalists may scrutinize thousands of potential investments annually, while investing ultimately in only a handful. The possibility of a public stock offering is critical to venture capitalists. Quality management, a competitive or innovative advantage, and growth of the industry are also major concerns.

Venture capitalists differ in their approach to management of the business in which they invest. They generally prefer to passively influence a business, but will react when a business does not perform as expected and may insist on changes in management or strategies.

Relinquishing some of the decision making and some of the potential for profits comprise the major downside to equity financing. If venture capital financing still seems like the ideal source of funding for your business, you may contact these investors directly, although they are known to make most of their investments through referrals.

The SBA also licenses Small Business Investment Companies (SBICs) and Minority Enterprise Small Business Investment companies (MSBIs), which offer equity financing.

What Do You Turn To?

The search for financing is similar to any other aspect of your business in that it takes time and effort to research the sources right for you. Examine your needs, plan how the funding will be utilized, and study what is available. The ability to secure sufficient funds to start and grow your business depends strongly on your preparation and demonstrated capacity to manage those funds efficiently and effectively.

Not All Money Is The Same

There are two types of financing: equity and debt financing. When looking for financing to meet your needs, it is important to consider your company's debt-to- equity ration -- the measurement between dollars you've borrowed and dollars you have injected into the business.

The more money owners invest in their business, the easier it is to attract financing. If your firm has a high proportion of equity to debt, you should probably seek debt financing. However, if your company has a high proportion of debt-to-equity, experts advise that you increase your ownership capital (equity investment) for additional funds. That way you won't be over-leveraged to the point of jeopardizing your company's survival.

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