The #1 Form of Startup Financing (Equity)

Equity - Why It's Great and Why Sometimes... It's Not

There are a plethora of capital sources available to startups and other high growth businesses. At Auxo we’ve seen them all, so we have a pretty good sense for what the benefits and drawbacks are of each. This week we're talking equity - the most popular form of startup financing.

The main benefit of equity financing is that the company is not obligated to pay back the investment, and typically as an operator you'll have more flexibility with how you deploy the funds. Additionally, equity investors are business owners alongside you, which means incentives are often very well aligned. Many equity investors pride themselves on their ability to add additional value through personal expertise or business relationships for the companies they invest in. This is especially true in the ultra-competitve venture investing universe! 

the main benefit of equity financing is that the company is not obligated to pay back the investment

The main drawbacks of equity financing are: 1) your equity ownership is diluted alongside everyone else, 2) you lose some “control” over the direction of the company as other equity owners will now have a voice and possibly a board seat, but in many cases this can be a good thing because you will have more opinions and ideas to weigh, and 3) equity can be time-intensive and expensive to raise.

Below is a breakdown of the most common forms of equity

1. Venture Capital - synonymous with startup investment, venture capitalists have backed many of the most successful companies in history, particularly within technology. Venture capitalists make big bets on companies that they think have the potential to return many multiples of their investment. Venture can be a great form of capital for high risk / high reward startups who are looking to take over or change entire industries. There are some downsides to consider though. Venture capital is often an expensive for of financing in the sense that they will take a material chunk of equity, and often with multiple layers of liquidity preference in the event of a sale or IPO. Additionally, because they tend to invest in a broad portfolio of companies, they are not quite as committed to any single one of their investments as a family office or private equity fund may be.
2. "Friends & Family" - Friends & family is an industry term for using your own network to raise capital from wealthy individuals. This is often the most “friendly” form of capital, both in terms of desired control / reporting, as well as terms on the investment. Friends & family rounds tend to take place early in a startups tenure when the funding needed is smaller, and the likelihood of a larger professional investor making a bet on the company is lower.
3. Angel Investors - Angel investors are typically wealthy individuals who are seeking to make investments in early stage companies. They are often somewhat similar to a venture capital investor (though this can vary considerably between investors), and can be both a good form of flexible capital as well as relationships and mentorship.
4. Private Equity and Growth Equity - Private equity and growth equity investors tend to look at later stage startups that need larger equity investments, or companies who are looking to be acquired.
5. Incubators - Incubators can be an exciting financing option for very early stage companies. Incubators will typically make a small investment (up to several hundred thousand dollars) in extremely early stage startups, or even ideas. Incubators are built around an ecosystem of mentorship and often have systems and resources in place that can help founders get their idea and business off the ground.

In a future post we'll explore more of the "why" behind our thinking that sometimes taking on additional equity financing is a bad idea. In the meantime, please reach out to us if you have any questions about your unique situation. Until then, keep building!