Financing your startup can be incredibly complicated from a legal standpoint. For the seed stage, it can be as simple as writing a check, but for anything beyond that, you will want financial experts involved. Investors will ask you about the legal structure behind the financing round.
That said, there are basically two ways to receive investment for your startup,
1) Debt Financing
2) Equity Financing
Debt financing is similar to a traditional loan. The investor will give you a certain amount of money for an agreed upon return-on-investment.
For example, let’s you raise $50,000 for your startup, and the investor wants a 15% cash return, annually. This is great because it is simple, legally speaking, and can be achieved fairly quickly. It also allows you to retain 100% control of your company since the investor doesn’t receive an equity stake.
However, there are some downsides to debt financing as well. The most obvious one is that you have to pay the money back. With the above example, you will owe someone $50,000 plus all of the accrued interest. Interest rates are typically very high for this type of agreement, especially if you are looking for seed money to support an unproven business model.
Some startups go to banks for debt financing. This can be an arduous process and approval rates are very low. The process is also much longer when dealing with banks.
The other option is equity financing- much more common in the world of fundraising.
Equity financing is just what it sounds like- money in exchange for equity. Instead of a 15% ROI on a $50,000 investment, the investor may want a 10% ownership stake in your company (usually a company sells no less than 10% during a typical first round equity deal).
The obvious benefit of equity financing is that you don’t have to pay the investor back, at least not in the traditional sense. Since the investor owns a portion of your company, he or she is entitled to a portion of your future earnings.
A not so obvious benefit of equity financing is the expertise and network of the investor. If a successful investor has an equity stake in your company, he or she may be able to help you in more than just financing.
Equity financing isn’t always a good thing however. Having an overbearing investor can be tough if he or she has different ideas for the direction of your company. Soliciting investment from individuals whose areas of expertise are aligned with the nature of the company is the right move – this is what’s called “smart money."
The last thing you need to know about equity financing is that it involves a fairly complex legal process. In most cases, it will take much longer than debt financing. If you decide to go this route, you will want to consult financial professionals.
One of the best ways to get your idea in front of qualified equity investors is through Syntiq. Through our advanced data segmentation, we connect startups with investors according to industry, region, size, stage, and dozens of other metrics.
To learn more about how Syntiq can help with your funding needs, go here.
Are you ready to seek investment but aren't sure how much you should raise? Check out our guide, Defining Your Funding Needs.