When should you go for equity financing?

Let’s take a few minutes to examine the kind of equity financing available to small or early stage businesses. In most cases, these applicants for equity funding  must be rooted in technology to apply to this limited discussion.

Friends and family investors

Here is a class of investor we’ve covered before, one usually focused upon you and less upon your business case.  We’ve worried together about the moral obligation implicit in taking such investments from people so close, even with their promise never to expect a return.  And we’ve spoken openly about your fear that you must succeed and perhaps even cover any losses – even without a formal promise or requirement to do so.  We’ll call these “inside angels.”  There is an exemption from the requirements that these investors be accredited with net worth or income minimums to qualify legally to invest in your company.

There are other classes of equity investors for small or early stage businesses that we have not yet considered.  Often grouped into formal organizations, these investors are sophisticated, helpful, and connected.

Angel investment groups or funds

First, angel investment groups and organized angel funds come in all sizes from a few organized angels to large groups of four hundred or more.  Each has a process in place to accept applications or recommendations for investment into new companies, and to review these and make decisions based upon their exploration, previous experience in the field, knowledge of the company or industry, or about individual entrepreneurs.  Angel groups invest from $250,000 to $1,000,000 or more in qualified investments.  Some can supply more when syndicating with other such groups.

How many angel groups are there?

[Email readers, continue here… ]   The Angel Capital Association (ACA) lists over four hundred member groups, located throughout the USA. The European Business Angel Network (EBAN), and similar organizations in other countries including Canada, all have web sites with directories of angel groups that are local to you.  And even though angel groups syndicate their best deals within their respective associated networks, it is always best to apply to the angel groups nearest your physical location.

If you have a virtual company with your employees working from home locations, as many startups do, it should be the location of the founder.  All angel groups will want to see the founders in person or by Zoom at sometime early in the process. Being in a distant city greatly reduces the chance of funding success.

Your expectations regarding time to funding and more

With angel groups and funds, you should plan of spending months in the process, from application through funding.  You will have to hone your story well, down to fifteen minutes and perhaps fifteen slides in your presentation.  Your opportunity becomes real when you are invited to present to the entire group via Zoom or hopefully soon at a lunch or dinner meeting, after which time one of the members or a paid group leader begins to seek commitments from the members to invest in your company.  You will be given a “term sheet” during the process, calling out the terms proposed for the investment.  These terms have become much more homogenized over the years, with many organizations adopting the same general form and terms offered to new investments.  Your principal focus may be on the valuation of the company before the investment is made, which determines the amount of the company you will retain after the investment.

Individual super angel investors

There is a rather new term for those large, individual investors who are usually former entrepreneurs made rich through sale of their previous ventures.  These “super angels” act alone or in informal groups and require that you find your way to them through personal introductions from their trusted associates.  The advantage to getting the attention of a super angel is that most operate informally and make quick decisions with little due diligence.  This class of investor typically writes checks from $50,000 to $250,000.

Accelerators

Accelerators are organizations that usually invest small amounts in startups and require the team to go through a process of from one to three months in which the accelerator staff helps to hone the message, train the team, and make introductions to larger investors – all in return for a relatedly small amount of equity, sometimes five percent.

Venture farms

This newest class of investor is most interesting but there are so few that they are hard to find and very picky in their choices of which companies to accept.  The strong advantage is that these organizations will stay with a company from acceptance to ultimate IPO or M&A sale, helping financially and with education, encouragement and introductions along the way.  These firms will continue to finance the company without VC money required, and in return keep the capital structure simple for the life of the company.

Then there is venture capital

Venture capitalists, rarely invests in startups, usually reserving their investments for companies that have star entrepreneurs they have worked with before, or companies brought to them by angel groups or other trusted sources.  VCs often invest no less than $2 million in a single deal, finding it difficult to put less money to work and still spend time on boards and coaching entrepreneurs to a successful liquidity event.  VCs need much higher exit values to justify their higher amounts of investment, and often want companies they invest in to be worth more than one hundred million dollars at exit, not a riskless task.

And the one thing in common?

The one thing in common with all professional or organized investors is the focus upon the exit, or liquidity event, in which the investors can realize a sale of their interest and a profit from their investments of time and money.  For early stage investors, the usual expectation is seven years from investment to expected liquidity.  When you take money from any of these sources, you make a pact to build, with their help, a business that can be sold or taken public, hopefully within that time period.

And the common expectation of your potential investors?

These professional investors look for at least ten times their invested money back upon the liquidity event, knowing that the odds of achieving that are only one in ten, and that half of their investments will probably die before any liquidity event at all.  They look for businesses that are in large markets, that can grow fast, and that can achieve revenues in excess of $20 million within five years of founding.  Those are difficult goals for most entrepreneurs, making this form of financing unavailable to most, but attractive to those that fit into these criteria.

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