When you’re about to begin the process of raising capital for a new business, there is one very important decision which you’ll have to make: whether debt financing or equity financing is a better fit for your business. Equity financing includes venture capital, as opposed to loans from banks and other traditional financial institutions, which fall into the category of debt capital.
The biggest downside involved in raising capital, whether debt or equity capital, is that it is necessary to qualify first and this can be particularly challenging in the case of equity capital. Venture capital firms are generally looking for companies which are growing rapidly and that have a good chance of issuing an IPO or being acquired by another company in the next couple of years. This means that you’re going to need to demonstrate that your company is able to compete in an industry which is growing quickly.
There is a lot of work involved in raising venture capital. You’ll need to put together a business plan complete with projected financials, possibly prepare slideshows and other presentations and perhaps hire outside experts to make your proposal stronger. After you’ve prepared your pitch and supporting materials, then the next step is to start networking and meet a venture capitalist or firm which invests in companies in your industry.
There is also the matter than raising equity capital essentially means that you’re selling a share of your company’s ownership for the funding you’ll receive. What this means for you is that once your company goes public or is acquired by a larger business, that you’ll have to share the proceeds of this liquidity event with the venture capital firm according to their proportion of ownership.
This is something which gives a lot of entrepreneurs pause but look at it this way: it’s usually better to own a smaller share of a large company than it is to be the sole owner of a small company. For instance, 10% of a company that’s worth $20 million is a lot more valuable than 100% ownership of a company whose worth is only $600,000.
Venture capital firms generally focus their investments in one specific industry and if they provide equity funding to your business, their stake in your company means that you’ll be able to access their expertise in the industry. In most cases, venture capital firms will require that they have at least one seat on your company’s Board of Directors. You should welcome this like you, their goal is to grow your company and then exit through an IPO or acquisition.
Another advantage of equity capital is that most venture capital firms have not only the capital your business needs to grow, but also human capital in the form of connections in your industry and experience which can help get your company off the ground.
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Raising equity funding from a venture capital firm also allows you to put your energy towards growing your company without having to worry about making loan payments in the short term. There’s no interest and no payment schedules as there are with debt capital. If yours is a company in its early stages of growth, equity capital can make all the difference between failure and massive success.
Peter