Finding investors for your small business can be a challenge. Whether you are in the early stages of forming a new company or have been around for years, you are probably reading this article because you know you are going to need an outside investment either now or in the future. Unless you are running an organization that you can bootstrap forever — cover all startup expenses yourself and then use business revenue to keep your company operating in perpetuity — there will come a time when you need a cash infusion from an outside source.

There are many ways a business owner can raise funds. Some entail bringing on debt through loans from friends and family or from banks and other commercial lenders. Others involve seeking equity financing, which involves trading a portion of ownership for capital.

This article will discuss two types of equity financing: private equity and venture capital investment. While these terms are often used interchangeably — private equity and venture capital both refer to investing in private companies — but they have key differences regarding:

  • What types of companies — early stage vs later stage companies — each invests in
  • What percentage of ownership they are seeking
  • How much capital they typically invest
  • Whether their goal is to take a company to an initial public offering (IPO) or shutter it at a profit

Understanding Private Equity

Individuals and private equity firms that seek opportunities for private equity investments usually prefer mature companies that have existed for a while and have a record of accomplishment. There are several reasons that a PE firm might want to consider an established company for investment. Some of these include:

  • The business in distress and they believe they can turn it around to become profitable
  • The business is not reaching its potential and they think they can add value and make it do better
  • They have some special interest or expertise in the business

Regardless of the reason you attract a private equity investor, it is important that you understand that the private equity investor expects a return on investment sooner than later. They are probably not interested in the long haul.

Not every private equity investment is welcomed, of course. Sometimes a private equity company will set up loans from additional investors on the outside so it can buy all of a public company's stock in order to turn it into a private enterprise. This type of leveraged buyout (LBO) won't affect small private business owners, but it can offer insight into the mindset of some PE firms.

Pros and Cons of Bringing in a Private Equity Investor

Because most private equity investors have a lot of expertise and a genuine interest in your business, you should be able to take advantage of this trust to turn your business around and/or help it grow. They may have industry insider connections and access to streams of commerce that have been closed to you. Sometimes having someone in your industry who can open doors can make a big difference in a company's performance.

This help and expertise, however, does not come cheap. Usually, a private equity investor is going to want to have a majority stake — which means becoming a general partner or majority shareholder with majority ownership and majority control — in your business. They will have — and will often exercise — the power to change the business whether you like it or not. This could include changing the make-up of the executive team, moving the business in a direction you don't agree with, or even selling the company if the right opportunity presents itself and they can make a profit.

A private equity investor can be your knight in shining armor, or it could be the kiss of (a hopefully at least profitable) death. If your business is your legacy and something you don't want to lose control of, then you might consider other ways to find an infusion of capital.

Understanding Venture Capital

If you are in the startup stages or own a relatively new small business, you might look for venture capital investors to help you get to the next level. While venture capital (VC) is considered a type of private equity investment, VC and equity investors have some striking differences.

VC firms and individual VC investors like riskier investments that have the potential for higher gains. A lot of VC investors like the adrenaline rush of jumping into an investment when there are still a lot of unknowns. They don't insist on a majority interest in or complete control of your business — they often take on the role of limited partner — and share your vision of growing a company over a longer period.

Pros and Cons of Bringing in a VC Investor

Like private equity investors, venture capitalists often bring industry experience, knowledge, and connections that you can leverage to achieve greater business success. This kind of association can be especially helpful to younger companies that venture capital firms and investors go after. And, because they are seeking a minority stake in your company, VC firms and investors leave you in control of your company while sticking with you long term.

The drawbacks of VC investments are what makes them desirable. For instance, each VC investor only seeks a smaller piece of your business, so you might not get enough capital infusion from one VC investor to meet your needs. If you have to find more investors, you dilute your equity a little more each time. If you get to the place where you need to have several funding rounds, you could end up with a minority ownership after all.

Attracting Private Equity and Venture Capital Investors

Equity investors — whether private equity or VC — want to invest in businesses with potential for profit. It is important that you, as the small business owner, take the time to create a solid business plan that explains why your business provides a great opportunity. Be sure to include:

  • Statements about your company's mission and its vision for the future
  • A summary of your products and/or services
  • Information about private and public market opportunities
  • Records substantiating liquidity
  • Details about how much money you hope to raise and what you plan to accomplish with the funds
  • How you will measure progress and success
  • What investors can expect in exchange for their investment (expected ROI)

Any investors interested in pursuing a private equity or VC investment arrangement will perform due diligence to ensure that you have been managing your business operations well — including keeping accurate accounting records — and that you have high growth potential or, at a minimum, the basis for reaching profitability.

Prepare for Equity Investor Due Diligence With Skynova

Running a startup company or managing an established small business is always a challenge. Along with making sure you have enough cash flow to begin operations, keep the business running, and continue to grow, you need to keep track of accounting matters. It is important that your business documentation is accurate and that profits and losses are properly calculated, especially in substantiating your company's valuation.

Skynova's business software and templates can help you easily manage your business so you can produce the records and information that investors will demand when doing due diligence and beyond. To learn more, sign up for a free trial and see how easy Skynova products are to work with.

Notice to the Reader

The content within this article should be used as general guidance to help you understand certain types of potential investors. The information provided may not apply to your specific situation. For all accounting-related matters, always consult with a professional to ensure your business is meeting relevant accounting and other financial reporting standards.