Equity capital or financing is money raised by a business in exchange for a share of ownership in the company. Ownership is represented by owning shares of stock outright or having the right to convert other financial instruments into stock of that private company. Two key sources of equity capital for new and emerging businesses are angel investors and venture capital firms.
Typically, angel capital and venture capital investors provide capital unsecured by assets to young, private companies with the potential for rapid growth. Such investing covers most industries and is appropriate for businesses through the range of developmental stages.
Successful long-term growth for most businesses is dependent upon the availability of equity capital. Lenders generally require some equity cushion or security (collateral) before they will lend to a small business. A lack of equity limits the debt financing available to businesses. Additionally, debt financing requires the ability to service the debt through current interest payments. These funds are then not available to grow the business.
Venture capital provides businesses a financial cushion. However, equity providers have the last call against the company’s assets. In view of this lower priority and the usual lack of a current pay requirement, equity providers require a higher rate of return/return on investment (ROI) than lenders receive.
Business “angels” are high net worth individual investors who seek high returns through private investments in start-up companies. These investors share many common characteristics:
- They seek companies with high growth potentials, strong management teams, and solid business plans to aid the angels in assessing the company’s value. (Many seed or startups may not have a fully developed management team, but have identified key positions.)
- They typically invest in ventures involved in industries or technologies with which they are personally familiar.
- They often co-invest with trusted friends and business associates. In these situations, there is usually one influential lead investor (“archangel”) whose judgment is trusted by the rest of the group of angels.
- Because of their business experience, many angels invest more than their money. They also seek active involvement in the business, such as consulting and mentoring the entrepreneur.
- They often take bigger risks or accept lower rewards when they are attracted to the non-financial characteristics of an entrepreneur’s proposal.
- Starting a business
- How to secure financing for your small business
- Funding sources
- Venture capital
- Angel investor
- SBA.gov - Financing a Startup