Raising Money Through Equity Investments
by
Attorney Fred S. Steingold
Learn about the pros and cons of bringing investors into your business.
Unlike a lender -- who temporarily provides you with money to operate your business -- equity investors actually buy a piece of your business. For better or worse, they become your co-owners and share in the fortunes and misfortunes of your business.
Here’s a look at the pros and cons of raising money through equity investors and the different forms this equity investment can take.
Investors' Rights
As co-owners of your company, your investors will have some say in the way you run your company. They will:
- probably be able to vote to elect your board of directors
- have a legal right to be informed about all significant business events, and
- be able to sue you if they feel their rights are being compromised.
On the other hand, investors can bring helpful business experience with them that can strengthen your company.
Investors' Return on Investment
People who invest in your business often accept the risk of losing their entire investment without guarantee of repayment. To offset this risk, investors often want to receive substantial benefits if the business is successful. For example, an investor may insist on a generous percentage of the business profits and, to help assure that there are such profits, want your salary capped.
The terms are always negotiable; there's no formula for figuring out what's fair to both you and the investor. In the end, you and your investors will have to work out what you are both comfortable with.
Your Ownership Structure
If you are considering having equity investors in your business, you must determine which ownership structure will work best for you and your investors.
General Partnership
If you recruit people to invest in your sole proprietorship, your business will, by default, become a general partnership. This means your equity investors will be general partners, each of whom is personally liable for business debts and liabilities, whether or not he or she takes part in running the business. To learn more about general partnerships, see Partnership Basics.
Many investors will want to insulate themselves from personal liability for business debts, particularly if they’re not going to actively participate in running the business. If that is the case, consider other ways to organize your business.
Corporation
Because corporations offer shareholders protection against personal liability for business debts (called limited liability), a shareholder of a corporation who doesn't participate in corporate activities and decision making is virtually free from liability for corporate debt or activity.
A shareholder who helps run the company can be liable to outsiders for his or her own actions -- for example, making slanderous statements or negligently operating a piece of equipment -- but isn't personally liable for corporate debts or the actions of corporate employees.
Not everyone chooses a corporation as their business entity because organizing and running a corporation involves some initial and ongoing paperwork, as well as some fairly substantial start-up costs. For more information on forming a corporation, read How to Form a Corporation.
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