Have you considered giving away equity in your business to avoid taking on monthly debt? A lot of would be business owners think this only applies to the friends and family who would be willing to act as a silent partner. However, there are plenty of other funding options out there that allow you to exchange equity for funding. Did you know you have your retirement account buy shares in your private business? We explore this and other equity funding options in this section!

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What is an Angel Investor?

When an entrepreneur has a great idea, or is in the early stages of their business and needs more funds to expand, they may look to find an Angel Investor as a means to get the capital they need. Angel Investors require an equity stake in your business in exchange for an investment of capital. The level of investment you could expect from an Angel Investor typically ranges from $25,000 to $150,000 and will require you to give up 20% to 25% of stake in your business.

While you may not think of your budding business as the next Google, Uber, Costco or Facebook (which all had angel investors), that doesn’t mean there isn’t someone out there who sees the same opportunity you do. Some of the key things angel investors look for when considering investments is your passion and the market opportunity you are looking to address.

Unlike getting money from friends and family, convincing an angel investor that you are a good investment will require you to button up every detail of your business or business plan. Expect to be grilled with questions as you go through meetings, due diligence and term negotiation. Raising capital from angel investors can be a grueling and time-consuming process.

When Using an Angel Investor Makes the Most Sense?

Seeking out angel investors is a great option if you are looking to obtain between $25,000 – $150,00 in capital and are okay with giving up equity but not control. Angel investors are typically making dozens of bets on companies and thus are not looking for a board seat, which is great for maintaining control of your own vision.

One very important element angel investors are looking for is a substantial return on investment (ROI). If you aren’t looking to grow your business exponentially and only want to sustain your lifestyle, looking for an angel investor may not be right for you. As these investors may see return on only ten percent of their investments, it is important that 10 percent can cover the losses they take on the failures.

If you are looking to start a business in an industry you don’t have a ton of experience in, finding an angel investor will have advantages beyond the capital they provide. They can act as strategic partners, providing advice and counsel when needed and will likely have insights into what strategies similar companies are utilizing. Most importantly, they can give your business credibility and access to more customers.

Lastly, because angel investors are looking at numerous opportunities and evaluating which will provide the highest ROI, you won’t be getting funding by just telling them about your business idea. You’ll need to craft an executive summary of your business plan and/or a pitch deck. A well-executed pitch deck will lay out your market opportunity and plans for marketing, PR and scaling the business. If this isn’t the sort of thing you want to spend time doing, seeking an angel investor likely isn’t the right fit.

How to Get Started With an Angel Investor & Where to Find Resources

Before you even start to look for or approach angel investors, you need to lay the ground work by having a well-prepared business plan. Download this eBook, How to Write a Winning Business Plan and review this in-depth article that looks at each section of a business plan to ensure your plan will wow even seasoned investors.

Once your business plan is air tight, it’s time to start working on your pitch deck. This article on the 11 slides to include in your pitch deck will help ensure you hit every point an angel investor will want to see. After drafting the content that will go into your pitch deck, you can purchase a pitch deck template, or check out 24 Slides to download some of their free templates.

Now that you have your business plan and pitch deck nailed down, it is time to get in front of angel investors. Much like crowd funding, there are websites that simplify this connection. Some of the top options are AngelList, Crowdfunder and Fundable. There are also networking groups that help introduce local entrepreneurs to investors, such as Angel Investment Network. There are also regional networks: for example, the Alliance of Angels operates specifically in the Pacific Northwest.

Hopefully all the work you put into your business plan and pitch deck will ultimately lead to investment offer. Then will come a term you may be unfamiliar with: convertible note seed financing. This is the preferred way for an angel investor to obtain equity within your business. We feel this article from TechCrunch is a great place to start your education, but ultimately consult your CPA and attorney before signing any agreement.

What it is Venture Capital?

Have an idea that can revolutionize the world or a small business that is primed to explode, but you just need more money to make that happen? Venture capital might be exactly what you need. Venture capital is typically given to start-ups or existing businesses that have high-growth potential, but also come with enormous risk.

It is for that reason that venture capital comes from venture capital firms, which are comprised of professional investors who understand the ins and outs of financing and growing early stage companies. Due to the risky nature of these major investments, VCs expect a high return and an ownership stake in the company. If you take venture capital, you can expect it to be a lengthy engagement— 5 to 10 years. Venture capitalists are waiting until they can sell their shares back to you, or to the public through an initial public offering (IPO). Through these methods, they hope to make a significant return on their initial investment.

The venture capital firms typically get the money they invest from wealthy individuals, private and public pension funds, corporations, endowments and foundations. It is worth knowing that while the money is coming from these sources, they are considered limited partners, whereas the venture capital firms are considered a general partner. It is this distinction that allows the venture capitalist to take an active role in setting direction and growing the company profitably.

Venture capital firms aren’t looking to make investments in Main Street Small Business, they’re looking for companies in the tech and healthcare sectors that can’t get money from traditional loans because their risk profile is too high. They are looking for the next Google, Facebook or FedEx — companies that are creating unproven models for way of generating revenue.

When Venture Capital Makes the Most Sense

Seeking venture capital makes sense if your business model is unproven, and thus presents too much of a risk for traditional loan options. Venture capitalists are less opposed to these risks — they know that one good investment can make up for several failed ones. VC also makes sense if you are looking for over a million dollars in capital. If you need less than that, you may consider looking for an angel investor. If you have a track record in your industry and are operating on a traditional business model you can also explore a Small Business Administration Loan (SBA). With an SBA loan, you can get up to five million dollars if you meet the right criteria.

This might seem obvious but is still worth stating: taking venture capital only makes sense if you are looking to hit the business jackpot. You’ll need to put in the work to grow your business at an aggressive pace to meet the demand of the VC firm. Remember, their end goal is to maximize their ROI in as little time as possible.

You must also be open to not having 100% control of your company. One of the first things you’ll lose control of if you take venture funds is the entity type. To issue shares of your company to the VC firm, you must convert your company into a C-corp. With these shares, the VC firm will gain a seat on your company’s board and the ability to influence business decisions.

One of the benefits of giving the venture capital firm equity in your business and having them as part of your board is that they can act as an outside partner and sounding board for you. VCs typically have deep industry expertise and connections, which can make growing and expanding your business much easier than trying to do it on your own.

How to Get Started With Venture Capital & Where to Find Resources

Just like the approach to attracting an angel investor, you will need to prepare an air-tight business plan. Further, it’s important to translate your business plan from thoughts to paper. Download this eBook on How to Write a Winning Business Plan and review this in-depth article to get started.

With your business plan showing how great your business is, it’s time to translate it into a pitch deck. Every pitch deck should include these 11 slides to highlight key information a VC will be looking for. You can purchase a pitch deck template, or use one of the free professionally-designed templates from 24 Slides.

Now it’s time to actually meet with a venture capital firm. Depending on your network, you might be able to arrange a meeting through a LinkedIn Connection. Or, like crowd funding and angel investors, there are websites that make this easier. Popular options include MicroVentures and Crunchbase. To help you learn which VC firm is right for you, check out TheFunded.com.

On another note, we recommend you read VentureBeat on a regular basis to get familiar with industry news. Also consider joining the National Venture Capital Association. Lastly, use The Beginner’s Guide to VC to learn more and find excellent resources.

What it is Friends and Family?

We’ve already covered friends and family in the self-funded chapter, so why are they included here as well? As only 40% of small businesses are approved for a bank loan, relying on friends and family is one of the most common funding methods. Money from friends and family can come in different forms: as a gift with no strings attached, as a loan to be repaid or, for the purposes of this section, as an investment with an equity stake.

Friends and family may be willing to give you funding in exchange for equity without having to go through all the questioning that would come with an angel investor. While getting “easy” money from friends and family is a no-brainer, it is important you clearly lay out what their investment entitles them to. Taking money from friends and family also has the potential to cause some awkwardness at family gatherings. Taking the time to outline the loved one’s involvement and educating them on your plan can help ease any future tension.

When Using Friends and Family Makes the Most Sense

If you are fortunate enough to have this as an option, getting money from friends and family is better than seeking a loan from a bank. As long as you’re comfortable with the agreement you put in place, not having a loan that has to be paid back will help increase your cash flow. This can definitely be worth sharing the future profits, as it is easier to turn a profit when your overhead is low.

If you have little industry experience or poor credit, friends and family might be your only option. Getting an SBA loan would be near impossible, and an angel investor will be looking for someone who knows how to run a business and has a history of repaying their debts (just like the Lannisters). Luckily, friends and family are less likely to pull your credit or look at your resume. Instead they’ll look at your passion and work ethic—which can be hard to quantify for banks and angel investors.

Some entrepreneurs choose to give away equity in exchange for funding to bring in funding. That is one of the benefits of working with an angel investor. Frequently they invest in industries they know well, so they can act as a sounding board or help you make the connections you need to succeed. This is where friends and family can come up short. They may not have the expertise or connections to help you run a successful business. Make sure you are prepared to go it alone or only accept money from friends and family who can act as a partner.

Even though accepting funding from friends and family can be the path of least resistance to starting your business, consider the repercussions of accepting money from people you see on a regular basis. You will be giving them a stake in your business, so the will want to know how their investment is doing. If you aren’t prepared to provide updates and have someone making suggestion for how to improve business, you might want to see if there are other funding options available to you.

How to Get Started With Friends and Family & Where to Find Resources

When dealing with friends and family, you don’t want to ask for a second round of money. Make sure to read this article on Burn Rate and download this burn rate calculator. This will help you determine if you are asking for enough money the first time. Make sure you are putting your best foot forward when asking for money by downloading the How to Write a Winning Business Plan eBook so friends and family know you are serious about your business.

Once you have a friend or family member interested in investing in your business, you need to determine what is a fair ownership percentage based on their investment. To calculate this you will need to establish a post-money valuation and a pre-money valuation.

First, to calculate the post money valuation let’s assume your aunt is willing to give you $50,000 for a 25% stake in your business. This would give you a post-money valuation of $200,000 ($50k/.25). Then calculate the pre-money valuation by subtracting the investment from the post-money. In this example that would be $200,000 minus $50,000, which equals a pre-money valuation of $150,000. From there it is up to you to decide whether you feel that is a proper evaluation of your business. Here is great calculator to determine what equity percent someone would be entitled to.

Lastly, not all business entities are created equally. Determine which entity type is best suited for your needs, including the ability to give away equity. We recommend you read this article on equity investors, which covers the different structures available to you: General Partners, Limited Partners, Corporations and Limited Liability Companies.

This option of financing will require you to give away securities in your business. Make sure you work with a business lawyer to setup the correct structure (check out this great resource for finding a business lawyer in your area).

What is Equity Crowdfunding (Direct Public Offerings)?

Equity crowdfunding was made possible in 2012 after Congress passed the Jumpstart Our Business Startups (JOBS) Act. The JOBS Act looked to address Direct Public Offerings (Equity Crowdfunding & Personal Investment Contracts) as a viable means to fund a business. Taking it from a highly regulated and complex process that used certain federal securities exemptions (referred to as Direct Public Offerings – DPOs) to something that can be executed across interest to the growing base of potential investors.

The JOBS provisions of the multipart bill were stalled in congress for three years after the bills passing, but in 2015 the final provisions were approved which made it possible for small business to raise money through equity crowdfunding nationwide. The key element the bill contained was allowing this to happen across state lines. The hope is these provisions make it easier for nonaccredited investors (aka local patrons) to invest in small business, like local coffee shops, breweries and boutique shops. Prior to this the only way to raise funds in this manner was through Direct Public Offerings (DPOs), which came with geographic restrictions and amount caps.

A direct public offering is using a federal securities exemption to directly sell equity to potential investors. DPOs go through an approval process that requires state regulators, so the rules vary from state to state. What makes DPOs attractive to entrepreneurs is they get to establish the terms of the offering. If those terms are approved by the state regulators, then an investor can choose to buy or not. This keeps the entrepreneur in the control of how they want to raise capital. You might not have known it but Ben & Jerry’s used a DPO to raise money from people in Vermont who wanted to back their socially conscious ice cream business.

There are three common ways a business can perform a DPO.

  1. This offering can cross state lines and comes in two versions. Version one has a cap of $20 million, no required financial audit, but you must comply with each states regulation. Version two has a cap of $50 million, doesn’t require you to meet each states regulation, but does require an audit and registration with the SEC.
  2. This offering can’t cross state lines. Prior to pursing this option, you must register with your state. Most states don’t have a cap on the amount of capital that can be raised through this exemption, but verify how your state regulates this exemption prior to your offering.
  3. This offering allows you to cross state lines if you comply with each states regulation. This option does come with a cap of $5 million dollars in capital that can be raised.

The type of DPO you choose will depend on your businesses unique needs. However, using any of the three options above allow you to offer common stock, preferred stock, revenue sharing and debt securities all under terms and conditions controlled by you.

Like a public offering, the DPO process will require due diligence, compliance with government regulations and tons of patience as you navigate it all. The DPO process is comprised of three steps, but don’t let the simplicity fool you, you will want to consult a professional to help you complete the process.

Preparation and Review: This is where you need to get all your financial records in order, decide what type of security you are going to offer. The end goal here is to make sure you have everything to create your Offering Memorandum.

Compliance Filing: Here you are submitting all the records you put together in step one to the required state and federal regulators. If you did everything correctly in step one, after some waiting you should look be moving to step three.

Selling Your Offer: The process to this point can take months, but once approved you can start to put your offering in front of potential investors. You then typically get one you to sell your offer and after that the times frame is subject to renewal.

We’ll end this section by stating that we took a highly complex subject and simplified it to give you a high-level, distilled overview. Before you go down the path of equity crowdfunding or direct public offering make sure to consult with a professional.

When Equity Crowdfunding or Direct Public Offerings Makes the Most Sense

If your business idea requires substantial funding to get started and you can’t bring together people from your network to make it happen, then equity crowd funding might be your best chance at securing the funds you need. Remember that this process can take months to complete so don’t use a DPO if you are looking for quick funding.

Depending on the route you choose there will be costs associated with obtaining these funds. If you go through an equity crowdfunding platform you are sacrificing your future earnings along with any fees required by that site. If you elect to use one of the more traditional DPO options, not only will you being giving up future earnings, but it will cost between $15,000 to $25,000 in fees to a firm that specializes in DPOs

Successfully raising funds through equity crowdfunding or DPO’s require your business to have a great story. Like crowdfunding, if you can’t generate interest from people through an equity crowdfunding site or impress a group of investors this won’t be a viable option for you. It also helps if you have a strong network of investors you can bring onboard. While this will help your success, the addition of Regulation A+ made it so that equity crowdfunding websites could exist, making it easier to tap into existing networks of investors.

How to Get Started with Equity Crowd Funding and DPO’s & Where to Find Resources

Before you venture further down this path make sure to take the time to do further research on the topic. This DPO FAQ and this article that takes you inside the JOBS Act should give you a better understanding of the nuances of this funding option. We also recommend this article in the New York Times looks at what DPOs are and provides some nice examples of other companies that have successfully used them.

The next step is choosing whether you want to utilize an equity crowdfunding platform or go the tradition DPO route. There are dozens of equity crowd funding sites, some of which we listed off in the crowd funding section as they allow for multiple styles of funding.

Before signing up on any of the sites pay attention to the fine print.

If you choose to go the traditional DPO route, take the time to speak with multiple firms, here are a few you might come across while researching DPO’s;

Then there is RegulationDResouces.com and InvestmentBank.com which provide additional resources if you are seriously considering this as an option.

What is Rollovers for Business Start-ups (ROBS)?

Rollover for business start-ups, also known as 401(k) Financing – in its simplest form is your retirement account owning shares of your private company. You might remember we covered that in the self-funding options section. While it is self-funded because you are using your retirement funds, you are in fact giving up equity, except in this case that equity is being given to your own retirement account.

As quick refresher, the Rollover for Business Start-up (ROBS) structure came to be through multiple provisions in the Employee Retirement Income Securities Act in 1974 when congress passed the law. It was designed to let would be small business owners use their pre-tax retirement funds in a manner that would grow their retirement account, and help increase options for small business funding.

Some people have a hard time wrapping their head around how ROBS is different from taking a loan or an early distribution, so it is important to look at ROBS through a lens of equity based financing. When you use the ROBS structure you are taking on a partner, like how you would with an Angel Investor or Venture Capital. Except in this case the partner is your retirement account and because they are your retirement funds, you are the partner. This is why there is not a payback schedule or income tax-penalty, instead you must split the proceeds of the future sale with yourself and your retirement account.

Let’s walk through an example that highlight this. Let’s say you decided you were going to put your love of food to work and open a restaurant. You determine you need $300,000 to get your business started and because you don’t have that kind of money just sitting in your bank account you decide to use ROBS. You use $30,000 of your own cash and $270,000 from an eligible retirement account. This would mean you personally own 10% of the business and your retirement account owns 90%. Over the next 7 years your business booms and you accept an offer to sell the business for $1.2 million. After that sale, $120,000 would go directly into your checking account, while $1,080,000 would go back into your retirement account. The great part about ROBS is that instead of sharing that $1.08 million windfall with an outside investor, you get that money when you decide to start accessing your retirement funds.

Hopefully this example helps you understand why entrepreneurs who want to start a business debt-free turn to rollover for business start-ups. The example highlights how ROBS works on the surface but to setup up there are five keys steps in creating the structure.

Form a C Corp First you need to create a C Corporation so you can issue a specific type of equity, qualified employer securities (QES). Without this entity type your retirement account wouldn’t be able to have equity in your business.

Setup a Retirement Plan for Your C Corp Once a C Corp s created, a retirement plan needs to be selected and setup. This is where you will be rolling your eligible pre-tax retirement funds so that this new retirement account can purchase the QES and be an equity holding partner in the business.

Roll Funds to the Company Retirement Plan This is where the name Rollover for Business Start-ups comes from. You roll your retirement funds from your personal account to the new retirement plan. This is how your funds get into the account to buy shares in your new company

The Company Plan Buys Stock in the C Corp With the funds in the company retirement plan, it can now purchase stock in the C Corp through a QES transaction. This is the step where you are taking on your retirement plan as a partner because it now owns equity in your company.

Use the Funds to Operate Your Business Now that your original retirement funds are available to the corporation, you can start operating and paying for business expenses. You can run your business fully funded without having to take on an outside investor. Instead you brought in your retirement account as a partner, which you control.

When it’s all said, and done, you get a cash investment from your pre-tax retirement funds that you can use to start a business, buy a franchise or purchase an existing business. What makes ROBS a great funding solution is you get to start debt-free and the business partner who helped fund your venture is yourself, so any future gains go back to you.

When Using Rollover for Business Start-ups Makes the Most Sense

If you want to bring in a partner through an Angel Investor, Venture Capital or Equity Crowdfunding and don’t get any takers, or you simply don’t want to give away equity to someone else, Rollover for Business Start-ups may be a better option before looking to pursue a loan.

Rollover for business Start-ups is a complex structure to setup correctly, so you will want to work with a trusted ROBS provider. Since you will be working with a company that is performing a service there will be a cost associated with the ROBS structure setup. ROBS is best for people who need more than $50,000 from their retirement funds to get start, if you need less than $50,000 you are better off exploring other options such as taking a loan or an early distribution.

You get to be your own funding partner. This means your personal credit history, work experience and vision for the company won’t be scrutinized, as would be then case when pitching to angel investors and VCs. Since you are directing your retirement plan to fund your business, you don’t have a payback schedule or a requirement to collateralize your house. If your business struggles, your retirement plan would take a loss, just like an angel investor or VC would if they made a bad investment.

With your retirement plan acting as an investor in your business, there are IRS requirements that must be met. First you must be an operating company. So, if you are planning on offering goods and services in exchange for money you are good. Secondly, Guidant recommends the business you are investing in be legal at the federal level since a government sponsored tax plan allows for this investment. If your dream is to own a marijuana farm in California, Guidant won’t setup the ROBS structure to be used as the funding source; you will have to explore other options in this guide. Lastly, you must be an active employee of the business, where a good rule of thumb is to work a minimum of 20 hours per week. The good news is there is no requirement for the type of work, it could be sweeping for or keeping the books.

Rollover for business start-ups allows you to partner with your retirement account and start your business cash rich and debt-free, but the amount you need to get started might exceed what you have. In cases like this, you can use ROBS in combination with other funding options, such as SBA or Seller Financing. If you need a 20-30% down payment for a seller financed transaction or an SBA loan, the ROBS structure can be used to obtain debt-financing for that down payment.

How to Get Started with ROBS & Where to Find Resources

To get started with Rollover for Business Start-ups you will need to chase down both old and current retirement plans to establish how much you have available. If you have switched jobs over the years and aren’t sure if you rolled your plans over; a great place to start can be just calling to the company’s main line and ask to be directed to HR or the benefits department to see who the custodian is. Another option is to look at LinkedIn for connections you have that still work there and see if they know who the custodian for the retirement plan is.

Our goal for the sections on Rollover for Business Start-up in both the self-funded and equity funded sections will provide a high-level understanding of how ROBS works, but this information is just the tip of the iceberg. To get a comprehensive self-learning experience read our 401(k) Business Financing: The Complete Guide. If you prefer to learn from one of our experts give us a call at 888-472-4455 and our Guidant Financial team will answer any questions you may have about the program.

If you believe ROBS is worth further exploration or are ready to pick a ROBS provider we would love for you to select Guidant Financial. We feel our reputation as the top a ROBS provider, dedication to customer service, our three-layers of risk mitigation and commitment to the small business owners set us apart from our competitors. That said we want to provide you with other options so if you don’t choose Guidant consider Benetrends or FranFund. Outside of those two, the other ROBS providers are focused on selling and have a poor reputation for putting the client first.

We want you to form your own opinion so if you would like to see how a third-party views the different ROBS providers, check out the Best Rollover for Business Start-ups Provider from FitSmallBusiness.com.