Raising Capital: Equity Primer
Raising Capital Through Equity Financing: A Primer
There are several ways to raise capital for a business, and each method has its place depending on your business's stage and objectives. In future posts, we’ll explore debt financing and compare debt with equity, but today, we’re focusing on equity financing—a critical tool for many growing companies.
This article will answer the following questions:
What is equity, and what forms does an equity investment take?
A deeper dive into the different stages of equity financing
When does equity financing make sense?
Key considerations before raising equity
How we can help assess your funding needs and close your next round
What is Equity, and What Forms Does an Equity Investment Take?
Equity typically refers to the exchange of a portion of your company (via shares, units, etc.) for cash or another asset, which could include the time and skills of a person in certain cases. Essentially, you’re offering investors ownership in your business in exchange for capital.
In the startup ecosystem, the equity funding journey often follows this general flow: Angel -> Pre-Seed -> Seed -> Series A/B/C/D/X -> Liquidity event (IPO or M&A). Of course, this trajectory can vary widely. Some companies may stop at early rounds, others might IPO sooner, and some may bootstrap their way to success without ever raising equity.
Here’s a breakdown of the common sources of equity financing:
Angel Investors: This is typically your friends and family round, supported by people who know and believe in you. These investors may contribute a few hundred thousand dollars (or much less). Jeff Bezos' parents funding Amazon is a famous example. Additionally, there are independent angel investors—successful entrepreneurs or professionals who invest and offer guidance. At this stage, your company likely consists of a solid idea and a co-founding team, possibly with a very rough prototype.
Pre-Seed/Seed: Usually, this is the first round led by a professional firm, typically raising around $1-5 million. Many pre-seed and seed firms offer services like shared office space, HR, and recruiting support to help startups accelerate. By now, your product should have evolved into a functional prototype, and your company is no longer just an idea.
Series A: You are starting to beat the odds as only around 40% of startups make it to this stage. Your company is starting to take shape, with some administrative roles filled, perhaps even by full-time employees. At this point, your product has hit the market, though profitability might still be distant. Series A rounds typically range from $10-20 million.
Series B: This round is where companies usually show real traction, with revenue generation and product-market fit starting to solidify. You’ve likely hired more senior leadership and begun building out your sales team. Round sizes vary, typically ranging from $15-40 million. However, industries like artificial intelligence, clean tech, or blockchain can command significantly larger rounds.
It's important to note that industries evolve, and what was once a "hot sector" can cool off, leaving companies struggling to secure subsequent rounds. For example, the rise and fall of blockchain-based startups underscores the importance of timing in raising capital.
Series C: The hardest round to raise, requiring strong product-market fit and impressive growth metrics. Series C funds are often used to scale go-to-market efforts aggressively. A successful Series C typically demands an annual revenue run rate of at least $10 million. Companies at this stage usually have over 100 employees and may add C-suite executives to strengthen leadership. Round sizes vary widely, from $15 million to well over $100 million.
Series D and Beyond: Fewer than 5% of startups reach Series D, a stage often marked by the need for additional capital to cover significant operational costs (burn) or delay an IPO. Uber is a prime example of a company that raised multiple late-stage rounds to fuel hypergrowth. At this point, companies are drawing attention from broader markets and attracting top-tier talent.
When Does Equity Financing Make Sense?
Equity financing offers numerous advantages, but it also has significant downsides, which we’ll cover in the next section. You should consider equity financing when:
Your company can handle the increased expectations and scrutiny. Venture capitalists (VCs) aren’t just interested in helping; their primary goal is to generate returns. If your company isn't positioned to scale to hundreds of millions in revenue or achieve a billion-dollar valuation, equity financing might not be the best fit.
You can’t raise debt. Early-stage startups that haven’t yet achieved profitability often struggle to secure debt financing, leaving equity as the primary option besides bootstrapping.
You’re ready to scale but need capital. If your product has traction and your team is solid, but you need more resources to take things to the next level, equity financing could be the solution.
For companies in industries that require heavy upfront investment (e.g., biotech, hardware), equity is often necessary due to the capital-intensive nature of their growth.
Key Considerations Before Raising Equity
Giving up Control: Equity means sharing ownership and this means that your rather large stake in the company can get significantly diluted (to the point of irrelevance if you are not careful). While this can bring better governance and external perspectives, it can also lead to founders being replaced. Decisions may take longer, and each transaction may involve extensive legal paperwork (hello lawyers!). Additionally, you’ll need to keep a board of directors satisfied.
Equity is Expensive: It’s one of the most expensive forms of capital. While you may not have to repay it directly, when it’s time to share profits or exit proceeds, those early equity rounds will take a significant bite out of your proceeds.
Finding the Right Partner: Investors come in all shapes and sizes. Some specialize in specific sectors, while others cast a wide net. Choose your investor as carefully as you would a co-founder. This is someone who will be deeply involved in your company for years and could make or break your experience.
Preparation is Key: To raise capital, you need to be ready. That means a polished pitch deck, clearly defining the problem, your solution, and why your team is the best to execute it. You’ll also need to ensure your product and customers are ready for close scrutiny. Finally, preparing your due diligence documents in advance can help you stand out as a well-prepared, professional operation.
Additional Reading:
Harvard Business Review’s article on How Venture Capitalists Make Decisions provides insights into the factors VCs weigh before investing.
Entrepreneur article on when is the right time to take institutional capital
On the topic of dilution via lightercapital.com and what to expect when you sell equity in your company
How We Can Help Assess Your Funding Needs and Close Your Next Round
As you can see, raising a round is complex—from determining the best time to raise and how much equity to give up, to preparing all the necessary materials. We’ve seen companies fail their raises due to weak storytelling and inadequate preparation, both of which are avoidable.
At Holdfast, we’ve advised founders through equity raises from Angel to Series C. Our experience can streamline your preparation, helping you maximize your chances of success. We’d love to hear more about your business challenges and how we can assist. Please contact us at daniel@hlfst.com to start a conversation.
