An equity investment agreement occurs when investors agree to give money to a company in exchange for the possibility of a future return on their investment. Equity is one of the most attractive types of capital for entrepreneurs, thanks to wealthy investor partners and no repayment schedule. However, it does require the most effort to find it. Fundraising with equity means that investors offer money to your company in exchange for a stake in the business, which presumably will become more valuable as your company gains success.
During the initial stage of fundraising, you'll determine a specific valuation of your company. In other words, you'll decide what your business is worth at that time. According to your company's valuation and the amount of money an investor gives to your company, they will own a percentage of stock in it. Once your company goes public or sells, they will receive back compensation in the same proportion that they invested.
For example, say the founders of Magnificent Puzzles have chosen to transform their small business into an international chain, and they are seeking $500,000 in equity investments. The company has been valued at $2 million. The venture capitalist firm Equity Excitement decides to invest $250,000, which means they will earn 12.5 percent equity in Magnificent Puzzles. In the future, when Magnificent Puzzles doubles in value, the value of Equity Excitement's initial investment will have doubled as well. Equity Excitement's investment is now worth $500,000.
Under some circumstances, equity fundraising makes the most sense. In other circumstances, it is the only realistic option for a business. A few of these situations include:
Like all forms of fundraising, equity investment has both advantages and disadvantages. One of the most beneficial characteristics of equity investment is that unlike regular bank financing, it does not require any regular payments. Investors look forward to a future opportunity to cash out their share of the profits. Another advantage is that equity investors (especially those known as "angel investors") can offer valuable advice and guidance that will support the growth of your business. Also, it's often easier to acquire early investments from your family and friends because they share your excitement in your success.
On the other hand, accepting investment funds from family and friends may create tension in the relationships, especially if you are unable to offer a return on their investments. Locating the right investor may also take much more time and effort than applying for a loan. Long-term business complications may also exist when you take equity investment. If you hand over a large chunk of equity in your company, you give up your exclusive control over both current and future business decisions.
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