Accessing equity financing

Some entrepreneurs borrow money to finance their businesses; doing so means they go into debt right from the start, and, in most cases, have to pay back their loans with interest. Equity financing, on the other hand, allows you to stay out of debt, but give up a percentage of your business and/or profits to an investor.

Some investors may want more control than others in exchange for their investment, depending on what expertise and connections they bring to the table, and how much time they have to help you run the business. You can negotiate the extent of creative and strategic control your partner(s) will have prior to signing any contracts.

The key to getting equity investors is preparation. You must prepare a strong plan in order to convince an investor that you know what you are doing and that your business is worth their time and money. Take the time to study the elements you'll need to consider before moving forward.

Table of Contents

Financial needs and performance

Begin with a thorough, strategic business plan that projects your financial needs and performance into the future and answers these key investor questions:

Preparing your plan and accompanying financial data can be time consuming. It also requires some special skills, as the economic environment is always changing. Management and external advisors may be able to help in putting it together.


Investors will look very closely at your business plan and projected financial statements to see if your business will generate an adequate return in a reasonable amount of time.

Your plan and financial projections must show, in detail, how you'll use the funds you get and how your business will perform over the next 2 to 5 years (long range).

Determining financial needs

To finance your growth initiative, you'll need to know how much of each of these types of funds you'll need:

Projecting performance

Investors will want evidence that you can actually achieve the gains that you forecast. They'll be looking closely to see if:

Your investment proposal should include:

Financial options

Your business expansion will likely tap into all three major sources of financing:

External risk capital investors, who will invest by purchasing equity shares, include:

Cost, control and risk

Risk capital sources will finance businesses that conventional sources may avoid. Risk capitalists will assume some of the risk of growth, but it will come at a price; you may have to pay more, or give up more control.

When you consider different types of financing, the key questions are:


Risk capital equity investment:


Equity financing involves a loss of control since equity investors will:

Not all entrepreneurs are ready to dilute their ownership — are you? Before you answer, consider that in many cases the investor's active involvement can be worth a lot, as they are providing management experience, industry contacts and other resources.


When you take on debt, you're adding risk because you're committed to scheduled interest and principal payments. On the other hand, if you accept equity investment, the investor assumes some of your financial risk. At the same time, you assume another type of risk, but also benefits from the reward that equity affords.

Investment potential

Investors are looking for three things. You've got to show them how your venture will deliver all three:

When capital is in short supply, you will also need to demonstrate why your business is a safer and more profitable investment than other potential ventures an investor could support.

Proving growth potential

Investors will look for evidence that you can actually produce the growth you project. One effective way to show them what you can do is to provide a situation analysis of your business. Analyze your company's:

Measuring return on investment (ROI)

To show investors what return they'll earn on their investment, you need to show them what your business is worth today and what it will be worth in the future. The reason is, equity investors make their money based on the change in the value of the company. If the business' value increases, their investment value increases.

Measuring your business' value — valuation — is a complex but critical process. You'll probably need the professional assistance of a financial advisor or business valuation expert to determine the company value.

Because the investor likely won't see any money until some years in the future, the best valuation method is one that assigns a present value to future earnings.

The specifics of your deal all hinge on the valuation of your business. The amount the business is worth will determine:

Getting the investor's money out

Investors will be looking for assurance that they'll be able to get their money out of your company. You've got to include such an exit strategy in your proposal to show them how they can realize their investment. The exit strategy also affects how the valuation is calculated. Exit strategies for equity investment include:

Management capabilities

Investors will look to see if your management team can implement your business plan and realize the investment potential.

They are not looking for an operation dominated by one person. Instead, they want to see a talented team with:

Assess your team

One of the key criteria for investors is that your team is able to take on the new challenges of growth. Assess your team's abilities and readiness for growth by comparing available skills to needed skills. You can do this using tools such as:

Prepare for investors

You'll have to provide investors with evidence of your team's readiness and competitive advantage. Be ready for tough, specific questions about each management function:

Strengthen your team

If your team is weak in some areas, start planning to improve it now. You can strengthen your team by:

Investment proposal

You need a concise and compelling proposal to grab the investor's attention.

The proposal may not be the same as your business plan. The business plan is often designed for an internal audience (namely your managers), to guide their work. The proposal is designed for an external audience, to sell your idea and raise the funds you need.

Investors want the proposal to give them an immediate understanding of:

The executive summary

The executive summary should be brief and complete. If it's successful it will encourage investors to read more. It needs to show them:

Getting the investors' attention

The proposal needs to capture the investors' interest by providing them with the information they need in an attractive and easy-to-understand style. Pay close attention to the writing and visual presentation.

Table of contents

A typical proposal contains the following sections:

Finding potential investors

Who are potential investors?

There are many different types of risk capital investors. Each one has different characteristics.

How do you find them?

Let people know what you're looking for. Look for introductions or referrals from:

Valuable contacts can be made through:

Other possible sources include the Internet, news articles on investment deals, professional and industry directories and listings, and local entrepreneurship centres or economic development units.

Who should you target?

Find investors whose criteria match your situation. These are the key areas to look for common ground:

Investor meetings

The first meeting with your targeted investor is an opportunity for you to make your investment proposal come alive. During the meeting, the investor will be looking for your belief in yourself and in your product or service. He or she will be trying to judge your credibility and integrity. It's also an opportunity for you to learn about your potential investor.

The agenda

Usually only a small group of people — you and your advisors, your potential investor and the investor's advisors — attends this first meeting. The meeting might include:

Preparing for the meeting

The first meeting is not a casual affair. You've got to plan the meeting and your strategy very carefully. To help prepare:

The investor's questions

Be prepared for tough questions. In fact, intense questioning can be a sign of stronger interest. The investor will be looking for answers to questions like these:

Your questions

You should be looking for answers to questions like these:


The term sheet

Negotiations will officially begin when you receive a term sheet from the investor. This is his or her response to your proposal, covering the main elements of the deal:

What's on the table

Price: The value of the business and the amount the investor will pay, and the share of the business they acquire are central to the negotiation.

Control: Investors will be looking for ways to control their investment, such as representation on the board of directors or some type of involvement in decision-making. As the entrepreneur, you have to decide how much control you can give up.

Performance measures: You need to decide what measures and targets for success that both you and the investors accept, and then you need to hammer these out (e.g. sales volumes, cash flow levels, debt repayment).

Exit strategy: You'll need to determine how and when the investor will be able to take his or her investment out of the business (e.g. sale of the company, initial public offering, share buyback).

Employment contracts: Contracts to ensure that key players keep their positions may be part of the financing agreement.

A negotiating session

A good approach to a negotiation meeting is to proceed along these lines:

Open the discussion: Briefly state the differences you see between the investment proposal and the term sheet.

Focus on interest and goals: Discuss your interests and listen to the investor's.

Find common ways to calculate financial elements: Some differences may be due to different assumptions or approaches in financial calculations. Try to get some clarity and consensus on these. Seek expert advice, if necessary.

Create alternatives that benefit both parties: Stay flexible and look for alternatives. Reserve time to explore possibilities and be creative about solutions.

Keep the future in mind: Be sure any deal you make leaves you with options for raising more funds in the future if required.

Hold multiple negotiating sessions: Use the breaks between meetings to develop alternatives, analyze the investor's position and get additional information to support your goals.

Closing and due diligence

Assess the deal

Take a good look at the deal from these standpoints:

Scrutinize legal and other obligations

Things to consider:

Due diligence

Before closing the deal, the investor will conduct a due diligence review to verify your information and to obtain more data, if necessary. Every investor will perform the due diligence review differently. Some will have advisors (usually from large accounting firms) to perform the task, whereas others will handle it themselves.

A due diligence review will generally include a detailed look at these main elements of your business:

Build and maintain good relations with investors

It's important to remember that the closing of a deal is the beginning of a relationship. For that relationship to flourish, you need good communication and trust. You can strengthen that relationship by making sure the investor gets all relevant information in a timely manner and is included in decision making.


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