If you want to expand your woman-owned business, you will need to raise capital. However, it can be a challenge to convince banks to give you a business loan, especially while your company is in the startup phase or entering your seed round. When push comes to shove, you will need to know your options for financing your small business startup. Below we will discuss the different ways to make equity investments that can help bring in liquidity, while also possibly providing an excellent return on investment for startup investors.
If you’re looking for more hands-on guidance, our company EnrichHER is a leader in the industry and can break it down for you. Join one of our training courses today and we can help you through the process. We specialize in women-led businesses and have an excellent track record of success for investors and companies alike.
Equity investments for financing businesses in an early stage
If you are searching for a unique way to invest your money, you should understand how early-stage equity investments work. Before detailing the three principal equity investments, it is crucial to explain the fundamentals.
There’s an opportunity for you as an equity investor to exchange capital for a percentage of ownership in a business. Female entrepreneurs often look for capital from family members, friends, angel investors, or venture capital firms. This provides business owners with easier capital than they could receive from traditional banks, while providing an investment opportunity to those who believe in and provide equity to a company. EnrichHER’s goal, however, is for the next stage of investment. We connect investment capital to companies to make financing as easy as possible, especially as they are scaling and grow profitable businesses. And there are certainly some benefits for entrepreneurs to raise capital from investors like yourself, because:
- As an investor you can fund a company, and also partner with business owners that you trust and believe in. When business owners have difficulty securing traditional funding, there’s an opportunity for you to profit by filling this need.
- People that provide equity investments typically look for future earnings from the sale of a business, a partner buying their company equity, or a public offer rather than ongoing monthly payments. As an investor, you can reap significant benefits by holding a portion of these businesses as they grow and mature.
- If, as an investor, you have certain skills or knowledge, you can use your resources to help your small business investment succeed. Female entrepreneurs typically use their investors’ expertise to expand their business. This can make it easier for the company you have invested in to succeed, and provide you with extremely attractive long-term returns.
As you now know, small business owners often prefer to find an equity investor to bring capital to their business, which can provide a high return investment opportunity for you. EnrichHER is here to make sure the right option is taken for the right investor and company. Considering this, what are the ways that you can make equity investments as an investor? We will break down several ways to structure equity financing deals, before discussing which small business fundraising option will suit you, as an investor. In the example below, we will be taking a look at investing in Kat Lady’s Kat Spa – an ‘up and comer’ in the feline business that is purring with opportunity.
Convertible Instruments: Convertible Promissory Notes
The first type of equity investment vehicle that business owners can use to raise capital is called a convertible instrument. Unlike exchanging ownership for an exact ownership value, convertible note negotiate terms with a maximum valuation value. Business owners use this financial method because it typically requires less negotiation, and it allows for investors to make an investment into the company in less time.
There are two main types of convertible instruments, the first of which is called a convertible promissory note, or “convertible note” for short. When the Kat Spa owner uses a convertible note equity raise, the owner will provide you with a convertible promissory note.
This convertible note works as a loan that can be transferred into some of Kat Lady’s equity, or principal plus interest, at the end of a specified term. Usually, you as an investor will provide funds to a company and decide which option you prefer, after a significant company event (10,000 kittens cleaned!) or during the next priced equity round.
For example, let’s say that you invest $10,000 into a company that’s raising funds using a convertible note. You’ll have an interest rate that you can earn on your principal once the term is complete. Normally, the term of the convertible note extends until a specific qualifying event, but it can also be time-based. There is often also a cap in each convertible note, which determines the limit of how much business equity you’ll receive as an investor after the next qualified priced round. EnrichHER has plenty of experience in this area and can guide you through the process. In this case, the Kat Spa has been shedding expenses, purrfectly scaling the business, and revenues have been fur-midable. You’re going to want to convert your note into shares of the company in this case, instead of taking the interest payment, given the amount of future growth available.
Simple Agreement for Future Equity (SAFE)
Alternatively, a company can decide to go with a SAFE, which provides investors like you with an equity derivative known as a warrant, instead of a loan. Instead of receiving your principal and interest as you would with a convertible note, the warrant gives you the “right to purchase,” not the obligation, preferred stock in a company after a future priced round. Think of it like the option to own just the kitten without the obligation of owning it throughout maturity. Of course, most people get attached, and want to exercise that warrant to keep the new family member around – hopefully the same thing happens with your SAFE investments.
This reduces the risk for the investor, but might not provide as much upside as getting into the stock outright, depending on the terms. If the company turns out to be awesome, though, you’ll want to exercise that right and continue to own.
Finally, there is a priced round capital raise. The process of investing in a company raising funds using a priced round strategy requires business owners and investors to determine how much the company is worth.
With a priced round, the company founders and investors agree on the specific dollar amount that the company is worth. How much are 5,000 cat shampoos and cuts worth over a 12-month period, less expenses? Throw a Kat Lady valuation in, and you and the Kat Lady will negotiate the amount of capital you will supply to become an equity investor based on the valuation.
Once you agree on an equity investment, the owner issues preferred stock to you and other investors. This preferred stock lets you reap benefits of the company as they grow and valuation increases over time.
A priced round provides a better understanding of Kat Lady’s Kat Spas Valuation than the other equity investment options. Still, it also requires business owners to complete a lot more accounting and negotiating to determine a fair buy in price for investors, which can be costly. Nevertheless, this type of equity raise often leads to a higher level of startup capital for the business founders, while also potentially giving you and other investors more ownership of the company.
Whether you choose to invest in a company securing funds through a priced round or a convertible instrument, or whether you receive a promissory note or a SAFE, depend on several factors that are specific to the company you’re investing in. Although we cannot determine for you and the business that you are investing in, we can list several pros and cons of both strategies.
Weighing Your Options: Priced Rounds vs. Convertible Instruments
- Priced rounds are a smart option for investors, as they will have priority treatment if the company goes through bankruptcy or liquidates.
- Priced rounds explain business valuation and lets investors know what percentage of ownership they will secure with their capital.
- Convertible instruments are more affordable and do not have the same legal fee cost to establish.
- Convertible instruments are an effective way to raise business funding from multiple sources throughout the business lifecycle.
- Convertible instruments are straightforward and easier to amend.
- Many of the investing terms with SAFEs are defined later. This benefits the business owners but leaves some details out which might be more helpful for investors to understand upfront.
Equity investments can be an excellent fundraising option when women-led small business owners are looking to bring in additional capital to their company, and do not mind sharing company ownership. This gives you an opportunity as an investor to possibly own a portion of a company or make interest on your principle by investing in a company.
If you are looking for an excellent way to invest in a female entrepreneur small business that you believe in, and straightforward terms, a convertible note will likely work best. Alternatively, if you only want to invest in a company once you understand that company’s valuation, or you want to invest a large amount of capital to fund a company, then priced rounds might be a safer investment option. They will take a longer time to complete and have more difficult negotiations, but often they are worth the investment of time. Would you like to discover excellent investment opportunities? Learn more about our latest cohort of women-led businesses that you can fund with EnrichHER.