Television makes it look like VC firms and Angel investors are lining up to take your great idea and give you all the money you need to get your restaurant or other venture off the ground. The truth is, only about two percent of small businesses have what equity investors are looking for—and unless you’re a sexy tech start-up or other company that can scale to exponential growth, you’re not going to have much luck with equity investors.
VC firms and Angel investors invest for a piece of the pie. They want equity. Because of that, they’re looking for a big payout within the next three to five years. They’re looking for companies where their relatively small investment will return an exponential gain ($1,000,000 turns into 10-20,000,000, for example). Knowing ahead of time that equity investors don’t reap the rewards of their investment until a business is sold or goes public, the focus of your new partner, will be to flip your company for a big return as quickly as they can. If you want to create a business that you spend the rest of your life running, that you can hand down to your kids, this type of funding is probably not what you should be looking for.
Although there are some benefits to Angels and VC firms, particularly for idea-stage or very early-stage businesses, it isn’t all a bed of roses. Other than my personal distaste for what is sometimes described as “taco chip” companies—companies with the long-term value of a taco chip, below are listed some of the challenges associated with equity-based funding, and what they might want from you in lieu of the monthly payment you’d otherwise be making to the bank:
- A management role: Most of the time, they’ll want to be added as a member of your company’s board of directors. They’ll want to ensure they’re in a position to increase the odds your company can be flipped into a positive return on their investment.
- You’ll may need to achieve milestones or objectives to receive funds: Unlike a loan, you might have to achieve milestones before they offer any cash. Funding is usually released in stages and typically allocated for growth and expansion.
- You’ll be giving away equity: Most VC firms expect some kind of equity position when they provide you with cash. And, depending on the amount of cash they give you, it could be a substantial position—maybe even a controlling interest.
- Some decisions might not be yours anymore: Depending on the VC or Angel, they might expect a voice in any of the major decisions you make. What’s more, they might not agree with some of what you might want to do. Equity gives them a seat a the table when big decisions are made.
Equity funding isn’t for everyone, but it can be a great way to get a good idea off the ground—you just need to know what you’re getting into before you get started.