Whether you’re working with a family member or a venture capitalist, you should be able to provide them with a viable business plan, a property and loss statement and information on any existing debt that your business has incurred to date.
While equity financing has nothing to do with your credit score, a venture capitalist may request a copy of your credit report in order to gauge what type of person you are. A low score may indicate to them that you’re not fiscally responsible. Be prepared to explain any negative marks on your credit report.
Equity financing is based on the value of a business. Small business owners can expect to value their establishments at two to four times their profit. A business that makes $200,000 in gross revenue with $40,000 in net sales can expect to value their business at two to four times the $40,000, or $80,000 to $160,000. The real multiple in which you calculate the value is net income.
If we use the example above at a 2% multiple and value your business at a reasonable $80,000, each share that you offer to sell is valued at $800. We determine this by using the calculation $800 x 100 shares = $80,000. If you need $4,000 to buy a new piece of equipment for your business, you need to sell five of those shares.
It’s important to note that if you grow to be a company valued at $10 million, those five shares would now be valued at $250,000.
There’s no timeline on equity financing. Your loved one could be very proactive and ready to give you the money tomorrow. You should, however, take the time to draft legal documents to protect you both, which would add to your funding timeline.
There are no repayment terms. You are selling a share of your company, not borrowing money. The lender has an ownership stake in your company.