A Primer on Equity Investmentby
Q: What would be the usual terms if I got a company to invest a certain amount of money in my new business? Would I have to sign away pieces of my company? —S.S., Arlington, Tex.
Private investors, whether wealthy or venture capital firms, usually expect to own some portion of your company in exchange for their investment. How much ownership stake (or equity) they take would be negotiable, based on how much is invested and what your company is worth.
Say your company is valued at $200,000, and an outside investor puts in $100,000. That person or group would typically ask for 15% to 20% of your company, says Jim Twerdahl, managing director of James S. Twerdahl & Associates, a Los Angeles investment banking firm. The percentage would fall on the lower end if you've built up the company by investing a considerable amount of your own time—and money. "Sweat equity counts for more if the owner has invested their own cash. Every investor today wants to see skin in the game," Twerdahl says.
You're also more likely to attract outside investment if your company is located in a region with an active venture capital or angel investor community, says Dave Shantz, San Diego tax practice leader at CBIZ (CBZ), an accounting firm. Many angel networks are listed online; the Angel Investor Network's Web site is one source. Venture capital firms are listed at the Web site of the National Venture Capital Assn.
Make sure you get professional help and exhaust all other possibilities before you agree to give up equity, says Shantz: "Selling equity gets very messy, so experienced attorneys and accountants must supervise every step."
Explore alternatives such as asset-based or Small Business Administration-guaranteed bank loans and "friends and family" capital. Or consider a strategic partnership, in which a vendor or other company would invest in your firm in order to share your technology, distribution channels, or marketing resources.
Generally speaking, even at reasonably high interest rates, the cost of debt is less expensive in the long run than an investment of equity, Twerdahl says. This is a particularly difficult time for a young company to secure bank debt, but if you can get it, that should be your first option. Asset-based lenders, sometimes called "factors," will take more risks on newer companies than a bank will, but the cost could be 10% to 12% per year when interest and fees are included.
An investment by a friend or relative is more likely to be paid back as a loan—with or without interest—than with equity. But overall, it will probably be cheaper in the long run—and better for you—if you can avoid giving up any equity. "Straight equity costs more than any other form of financing," Twerdahl says.