Types of investors
Equity financing has become more popular in recent times, due largely to the growth in tech industries. Banks were less willing to take a risk on these types of startups but private equity investors could see the potential, put their money in, and were richly rewarded. It gave rise to a bigger investment community.
The easing of investment restrictions has opened up opportunities for ordinary people to invest in a business.
The main sources of equity financing are:
Wealthy individuals who invest their own money in exchange for a share of the business. They generally want to be involved in business decisions and may want to cash out after a few years. It will help if you can present a profitable exit strategy for them. An angel investor might be someone who wants to invest in your industry, or your community.
A platform where you can raise funds from the public in exchange for unlisted shares (equity) in the business. This is generally for consumer products or services (not B2B) and you’ll do better if there’s a wow factor to what your business is planning to do.
Venture capital (VC) firms
Professional investment companies which invest their clients’ money in exchange for a substantial share of the business. VCs prefer to invest in companies that they expect to deliver massive and preferably fast growth.
Friends and family
Those loved ones who support your dreams with their own money. Many budding business owners turn here as a first option – or as a last resort.
Business incubators and accelerators
Development schemes to build and boost small businesses. Some will focus on a specific industry, and there’s often a tech focus. Accelerators are more likely than incubators to have seed money to invest as they’re focused on scaling a business they see has potential, rather than innovation.
Are you ready for equity financing?
Equity financing isn’t an option for every type of business. It’s not suitable for sole traders. If you want to sell shares, you’ll need to be a company (although you can sell an interest in a partnership). So you need to have the right business structure before you head down this route.
How big is the pie?
Having a lot of shareholders might put off larger investors in the future. So consider carefully how many investors you want to take on board. Think about how you want to structure any deal alongside the debt funding you already have or might take on in future.
Know your worth
Know the value of your business – get a professional business valuation done. Then you know what you’re swapping or selling in exchange for funding.
Before you commit to seeking funding this way, talk to a lawyer and accountant about the legal and financial implications of equity financing. Research and understand any current and upcoming regulations and laws you’ll need to comply with.
Where to find equity financing
Your first step to finding equity funding is to check what types are legal in your market. For instance, equity crowdfunding platforms aren’t permitted in all countries. In the US, UK, Australia and New Zealand equity crowdfunding is allowed.
Central and local government websites should have information about registered venture capital and crowdfunding platforms and any regulation requirements.
Other places to check are:
- Business incubators and accelerators: They may have seed money (to help to start a business) to invest and they have access to angel investors.
- Small business and industry associations: They may have information about equity funders their members have had success with.
- Your accountant or bookkeeper: They may have other clients who’ve been successful getting equity funding. Or they may have clients looking to be angel investors.
- Your bank: They might be able to put you in touch with equity funders or venture capital firms.
- Friends and family: They may be more patient about getting a return and not want to exit the business as quickly. Or they may know other people wanting to invest.
What makes a good investor for your business?
If there’s ever a time to look a gift horse in the mouth, it’s when you’re considering investors for your business.
While it can be tempting to shout an emphatic “yes, please!” at someone offering you money, stop yourself. Not all investors are created equal. Before you get yourself saddled with someone incompatible here are some qualities to look for. Ideally, they’ll be:
- local – so you have access to them, and they don’t forget about you
- in your industry – so you can draw on their experience, enthusiasm and contacts
- connected – so they can introduce you to the right people
- committed – so they’re with you for the long haul
The right investor can offer more than just their cash. They can share their experience and connect you with the right people to help your business grow. For example, they might introduce you to new customers, great suppliers, lawyers, accountants, bankers, other investors, business advisors, or contacts in the media.
What does an investor want to know about your business?
Investors want to know you’ll make money for them. They’re not out to steal your ideas. That said, make sure you file any necessary patents, trademarks and copyright paperwork before you start working with them, just to be sure.
It helps to understand what makes an investor tick. When you know what they want from you, you can present a far more compelling pitch. They want:
- Growth potential: They’re taking a bigger risk than a bank and so they expect fatter rewards. They want to back businesses that they think could explode.
- Involvement in the business: Most want to protect their investment by personally helping the business grow. They’ll need assurance that you’ll listen to and act on their advice.
- Dividends or climbing share value: They’re investing to get a return. That can come as a dividend (profits shared among shareholders) or as an increase in the value of the business (so they could potentially sell their shares). You need to show them you’ll be able to deliver one of those things. And be aware that to help them eventually cash in their shareholding, you may also need to sell yours!
- Personal investment: If you’re not prepared to put any of your money into the business, why would they be attracted to invest? You’ll need to put up a good portion of the funds.
- Your exit plan: Let them know if you want to build the business quickly and flip it. Or if you’re in for the long haul. There’s nothing wrong with either strategy. But your investors will want to know your intentions.
How can you impress potential investors?
Show you want to make money with them and for them – not just take it from them.
What’s your plan?
Show them a solid business plan and demonstrate sound financial thinking. They want to see that you can grow fast, and have a plan for delivering good returns and increasing the value of the company.
What’s their plan?
Talk about their plans too. Where do they see the business going and how involved do they want to be?
Take the time to prepare the necessary documents and complete everything they require. Send them your prepared documents ahead of meetings so they have time to review them.
Check how you look online
If your company has an online presence, be aware potential investors may look you up to find out more. Is there anything you wouldn’t want them to see? Can your social media work in your favour and show the potential for growth through your fans and customers?
Being competent with your pitch is a good sign that you’ll be competent running a business. Check out our chapter on building a funding pitch.
Are you looking for an angel?
Relatively few businesses can attract investment through VCs, crowdfunding, or accelerators. If you can’t either, then you probably need an angel. Our next chapter looks at them in more detail.
Disclaimer: Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the provided content.
How to finance your business
Need finance for your business? Learn about the types of finance, approaching lenders and investors and more.
- What is business finance?
Your new business idea is ready to go. Now you need to find the right small business funding. But where do you start?
- How much business funding do you need?
Knowing how much money you need will help you choose the right type of finance. These tips will help you find a number.
- Debt versus equity finance
Most forms of funding fall into one of two camps. Let’s look at the main pros and cons of debt versus equity.
- Main types of finance
It takes money to make money. So what sort of finance options are there? Here are the types that fund most businesses.
- How to get a business loan
Getting a business loan is still one of the most common ways to finance a business. So let’s look at how to get one.
- Peer-to-peer lending
Peer-to-peer lending is an alternative method of getting a business loan. How does it work?
- Friends and family loans
Friends and family loans may be available when other types of finance aren’t, but they do require some precautions.
- Invoice financing
Ever thought your cash flow would be better if everyone just paid what they owed you? Well, you may not have to wait.
- How to find investors
How do you find investors for equity financing? Let’s look at what types there are and where to locate them.
- Angel investors versus venture capitalists
Angel investors and venture capitalists are alternative finance sources. What can they offer your business?
- How crowdfunding works
Crowdfunding can get you the money to build a business, and the attention to build a customer base.
- Small business grants
Grants are a great funding option for some businesses. They can be a lot of work to get, but the reward is free money.
- Pitching for business funding
Seeking business funding is a major step but you needn’t be daunted. Here’s how to pitch your business.
- Tools and guides for your business
Now that you’re in business, you want to stay there. Xero’s got resources and solutions to help.
Download the guide to financing your business
Your intro to the different types of finance, including their pros and cons. Fill out the form to receive our finance guide as a PDF.