Equity financing is a type of business funding where a company gets money by selling a percentage of ownership to investors. This is different from debt financing where businesses borrow money from lenders and pay it back with interest and the business owner retains ownership of the company.
Unlike small business loans, equity financing doesn’t have a requirement to pay anything back. Investors own part of the company and get paid a percentage of future profits. The investors also get to vote on major company decisions like board appointments, mergers, and asset sales. Voting thresholds depend on shareholder agreements, corporate bylaws, and share class structures, but investors with sufficient voting power can force the company to make certain decisions including:
Accepting or turning down a buyout offer. Hiring or firing a CEO or board member. Taking a specific strategic direction.
Funding a business through equity financing spreads out the risk across the other investors, but gives the business owner or founder less control over decision making. This makes equity financing a good option if you’re:
- Starting your first company and don’t have revenue yet
- Launching a risky international expansion
- Buying a competitor’s business and this is your first merger
The tradeoff when there are investors is that you have to share the upside as the investors keep a share of the profits and if you don’t believe in the direction the company is going, you may not have a say if you get outvoted.
Once you’re ready for investors, choosing the right type of equity financing is the next step and will depend on your business stage. Different types of investors focus on different business sizes, maturity, growth rate, and the amount of control they want to have as investors. Here’s how they compare so you can determine what best fits your business needs.
The Types of Equity Financing
The most common types of equity financing for a company are:
Angel investors Venture capital Private equity Strategic investors Crowdfunding (equity-based) Initial public offerings (IPOs) Friends and family funding
| Type | Typical Ownership Stake | Business Stage Focus | Decision Making and Operations Involvement | Typical Investment Size |
| Angel Investors | Small | Early-stage / Startup | Low | Tens to low hundreds of ‘000’s |
| Venture Capital | Small to Majority Owners | High-growth Startup | Low to High (often board seats) | Millions to Billions |
| Private Equity | Medium to Entire Company | Established / Mature | Medium to Full Management | Hundreds of thousands to Billions |
| Strategic Investors | Small or Minority | Growth-stage | None to Low | Tens of thousands to billions |
| Equity Crowdfunding | Small | Early to Growth | None or Very Minor if any | Small dollar amounts |
| Initial Public Offering (IPO) | Minority to Entire Company | Mature companies | Low unless activist pubic investor | Hundreds of millions or billions |
| Friends & Family | Minority | Startup | Low | Depends on your friends and family |
Once you determine the right type of equity financing, talk to people in your industry about the top investors for the type of equity financing you need as different investors may focus on different areas. Some venture capitalists only fund tech firms, some private equity companies only buy manufacturing businesses, and some angel investing groups only work with specific local regions. By knowing the investors that focus on your space, you can save time pitching ones that wouldn’t be interested in your business.
What Each Type of Equity Investor Looks For
By showing up with a pitch deck and data that matters to the specific type of equity investor, you can create a stronger impact. This includes talking about what matters to them, knowing how their style of equity financing will benefit your business at its current stage, and removing things that may not be as important to their needs. Here’s a bit more about what each type of equity investor is and what they look for.
Angel Investors
Angel investors are individuals who invest their own money into early-stage companies in exchange for equity. They can be individuals or investing groups and are motivated to help young entrepreneurs with both money and mentoring. Angels invest smaller amounts ranging from tens of thousands of dollars to the low hundreds of thousands of dollars and typically expect a large multiple return on their initial investment.
This makes angel investors a possible fit if you have a prototype where you need money to get it produced, or have an idea where you can’t execute it without hiring a team. The expertise, network, and mentorship of angels also comes in handy if you need introductions to customers or distributors, advice for skills you haven’t learned yet, and if you need to navigate a complex regulatory framework.
Venture Capital (VC)
Venture capital firms raise money from groups of outside investors and combine the funds to make large investments in equity financing of companies. Venture capital firms exist for every industry including B2B services, healthcare, manufacturing tech, logistics, and there are even VC firms that focus on small businesses.
Venture firms target companies with rapid growth and the funding usually comes in “rounds” where each round gets bigger and bigger. For example:
Series A – starting marketing and advertising. Series B – scaling production and team size. Series C – building new products / services and entering new markets.
Many VC firms also take an active role in the company either by participating in strategic decisions like product direction and new market entry, or by sitting on the company board. This makes venture capital a bad choice when you want to retain complete control over both day-to-day and long-term strategy.
Private Equity (PE)
Private equity is similar to venture capital — firms raise money from many investors and pool it together to invest in companies. Private equity focuses more on turnarounds, stable, or steadily growing businesses versus the hyper growth focus from VC.
This means if you are looking for startup capital, PE firms are not a good option given that they want businesses with established revenue and operations.
Private equity financing deal sizes range from minority stakes (owning less than 50% of voting shares) where they invest “growth equity” and possibly add some operational expertise to buying out your entire company. This makes PE firms a great option when you need some help to grow or you’re ready to retire.
Another use of this type of equity financing is buying a competitor or a complementary business because you can lean on the operational expertise of the private equity firm to help with the integration.
Strategic Investors
Strategic investors are other companies that provide equity financing because they have a vested interest in your company succeeding, usually as a customer or supplier.
You could have a unique technology they rely on for one of their products, or be the sole customer for one of their new product lines. They want to make sure you succeed while also having a say in your decision making through their ownership stake.
You won’t have to give up much control because strategic equity financing is most often hands-off for day-to-day operations, and it is much more rare than the other types of equity financing. If you have the right relationship it is a great option to solidify a business partnership through direct investment in your company.
Equity Crowdfunding
Equity crowdfunding is a type of equity financing where you get multiple tiny investments from individual investors, usually from a crowdfunding website where you post an investment offering. This is mostly used for new companies or new products, but crowdfunding is also possible for service businesses and B2B companies.
You likely won’t be able to raise huge sums of money through crowdfunding, so it’s not great for major funding needs. If you are doing something where you need to generate buzz for a product or service, crowdfunding can be a good option because the large crowd of your new investors is a built-in marketing tool.
Initial Public Offerings (IPOs)
An IPO is when you sell ownership in your company through public stock exchanges to individual investors. The news covers the multi-billion dollar headline IPOs, but smaller companies can raise more modest sums through a public offering, like on NASDAQ.
IPOs offer the potential for a large amount of capital, but the trade-off is it comes with huge costs where you have to comply with government regulations and reporting requirements that cost time and money, and can create legal liabilities if you make errors.
If you have grown your small business into a nationwide franchise, or your technology business has grown into a global powerhouse, IPOs might be the right move. For most local or regional businesses, one of the other types of equity financing will be a better option.
Friends and Family Funding
Equity financing from friends and family is the way many businesses get started. The people in your personal network are often willing to take a chance on your idea when traditional investors won’t.
This type of equity financing can also be a good idea when you already have a business that is succeeding because you can let friends and family participate in your success while giving them a good return on their investment with limited risk.
No matter what stage your business is in, it’s a good idea to formalize the investment with real paperwork. This way you can reduce the risk of damaging the relationship as best as possible if things go south. Make sure the paperwork includes:
A clear statement that they could lose all or a large portion of their investment money. No expectations of specific upside returns. Specific expectations for communication frequency, what you will let them know about the business measures and the financials, and what you will not share. Their specific ownership percentage and any voting rights.
Equity financing is an umbrella term for raising money by selling ownership in your company to outside investors. It gives them a share of profits, a say in how the company is run based on their ownership share, and it doesn’t require you to pay anything back if the business fails. Choosing the right type of equity financing depends on your company stage, how much you need, and how much control you’re willing to give up and you can use the table from the earlier section to guide your decision process.
National Funding does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
