Trading Equity For Cash In A New Business

Practically every new business which is created starts out with a great idea that usually needs shaping, molding and a lot of long hours and hard work if it is to become a viable and competitive member of industry. However, most business do not reach the level of industry competitor without some kind of monetary investment.

Let’s face it, after you’ve been awaken in the middle of the night, or stayed awake with a business idea that you’re convinced will change the world, only to learn next morning that you’ll need money to get the business moving. What do you do if you don’t have that ‘seed money’?

If you own a home, you’ll remortgage (refinance) it. Take it from me cause it’s what I did to start my own real estate agency in the 1980s. I was fortunate enough to have owned a home, but not everyone with a great idea for a business owns a home. So what are some other options?

Investors and Equity

Practically every economy is built upon the backs of small business and entrepreneurship practioners. Every day someone comes up with an idea that will make a great business. Every day, these same people wonder how they will come up with the cash to get the business off the ground. The classic answer is to look for investors, and this is where things can go bad.

If you’re seeking investors for your business, you are going to need to form a business entity. Corporations and LLCs (Limited Liability Companies) are the most popular, and give you the ability to trade ownership interest in exchange for cash contributions.

With a corporation, investors will buy shares in the corporation. With limited liability companies, the investors will buy membership interests. Regardless, this traditional exchange gives rise to a problem common among small business owners. They often end up giving away too much equity.

From Joy to Misery

A common mistake made by new business owners is to give away too much equity when getting initial cash contributions. This occurs because they let insecurities impact their evaluation of the business. Instead of giving away two percent of equity in exchange for $50,000, they often give away ten percent. Let’s look at an example.

An industrious person starts a business selling digital gadgets. S/he prepares a business plan and realize s/he needs $250,000 to get everything up and running. s/he has $50,000, but need to find the rest somewhere. So s/he forms a corporation with 1,000 shares and start approaching potential investors.

S/he offers 100 shares for $25,000 and finds five investors that invest $125,000 in exchange for 500 total shares. In summary, s/he now has $175,000, but has given away half the equity in the business. While s/he is not happy about this, s/he is still so excited and enthused about the business idea that s/he shrugs it off.

The business gets rolling and s/he starts selling gadgets like crazy after one year. This gives rise to a serious cash problem because s/he’s getting orders, but can’t fill them because of cash flow problems. To make a proper go of the business, s/he needs another $100,000.

Where is s/he going to get $100,000? The business is only one year old, so a bank won’t touch it. The original nvestors haven’t seen penny one back, and are unwilling to put more money in. The only option is to sell another 400 shares for $100,000. Fortunately, s/he sells the shares, raises the money and stays in business. However, there is a major problem.

In raising all of this money, s/he has now sold off ninety percent of the equity in a business S/HE started, but now s/he’s left owning 100 shares and only 10 percent of the business. This is going to severely impact this owner’s physical, emotional and overall motivational well being. Slowly but surely, s/he’s going to become very bitter. It was s/he that had the idea and s/he is doing all the work! It really isn’t fair that s/he only owns 10 percent of the business! But that’s how it is. End of example!

On second thought, this impression may come on very quickly. Regardless, the business is destined to experience major problems because the primary motivating force is no longer motivational. Unfortunately, many people with business ideas run into this problem.

If you are starting a business, guard your equity at all costs. Selling equity should be a last resort. Try to get loans or trade profit sharing in lieu of selling equity. If you must sell equity, do so only in small percentages. You do not want to be the small business person in the example above.

Handling Failure The Successful Entrepreneur Way

There are many differences that separate the winners in business and life from those who are struggling and falling by the wayside. One big difference is how they handle failure. Successful entrepreneurs have a positive mindset around the experience of failure. When they fail, they look at it as a result. In other words, they took “x” steps which produced “y” result. Since “Y” didn’t work, it’s back to the drawing board to change the formula and try again.

Many new business owners don’t make it out of the gate because as soon as they fail, they figure, “Who am I kidding? I knew it wouldn’t work” and then quit. In other words, they were unable to convert stumbling blocks into stepping stones which inevitably lead to failure. If everyone had that mindset, we wouldn’t have electricity, airplanes, vaccines … actually, we’d have pretty much nothing.

Every single success in this world was preceded by one, two — a thousand failures! Babe Ruth set a record for the most home runs. Did you know he also had the record for the most strikeouts? Thomas Edison failed more than a thousand times before he perfected the light bulb.

If you’re not failing, you’re not pushing yourself enough. You are remaining in your comfort zone and cannot expect to reach the level of success you’re capable of. Failure is what allows you to learn and grow. If you quit as soon as you meet with failure, you will always remain exactly where you are.

Albert Einstein once said, “You cannot solve a problem with the same level of thinking that created it.” And, “The definition of insanity is doing the same thing over and over and expecting a different result.” What these statements teach is, in order to overcome failure, you must think differently and act differently. It is what separates the ordinary from the extraordinary.

You might have to seek out guidance from someone else who can offer the expertise you need. You may need to inject new perspectives and talent by forming a team around your project, but fear of failure is one of the biggest obstacles that hold new business owners back. Failure should not be feared, but embraced because a life lived in fear is a life half lived.

If you’re stuck and unable to move forward because of fear of failure or because you have failed in your previous attempt, bring someone else into the mix to offer support and guidance. Tweak your plan and give it another go.

Engrave the words of the following masters into your mind and never, EVER give up:

  • Anyone who has never made a mistake has never tried anything new. – Albert Einstein
  • He who fears being conquered is sure of defeat. – Napoleon I
  • Problems are not stop signs, they are guidelines. – Robert Schuller