In equity-based financing, an investor will provide capital for a startup that they believe has the potential to provide a high return on their investment, in exchange for partial ownership of that company. There are typically three different types of parties who will provide equity-based financing: angel investors, venture capitalists, and startup incubators or accelerators.

While equity-based financing is straightforward in the abstract (money for ownership), often the terms of the financing are much more complex. This FAQ is meant to be a high-level overview, we recommend working with experience legal counsel on equity-based financing.

Equity financing is most common in tech, but can reach all types of businesses, especially in the angel level.

Usually validated business model at a minimum, most frequently some revenue or customer validation, or traction of some kind.

These types of businesses are always driving towards some kind of “exit”: either becoming a public company via IPO, SPAC, or direct listing, or being acquired by another company. The ownership of the company is divided into “shares,” or pieces of the company, and the more you own, the larger the slice of the pie you get at IPO or sale. As you give up more and more ownership through subsequent funding rounds, the amount of money you’ll be able to receive will diminish significantly. Many founders own less than 15% of their company by the time they IPO.

Your investors are taking on the risk rather than you, so if the company shuts down, the only thing at risk is your reputation. You won’t owe any money or have your personal finances put at risk in any way.

Angel investors are often single individuals who are willing to give small amounts of money (typically less than $100,000, and sometimes as small as $1,000) to businesses they support. They usually don’t take a very active role in the company and the amount of ownership tends to be small, but they can offer advice and mentorship if you want it. The types of businesses they invest in can vary wildly based on the personal interests and personal connections of the investors—for example, they could invest in a software company they believe will be successful, but they could also invest in a friend’s local gym.

VC firms tend to invest in extremely high-growth companies, or companies they believe have very high growth potential. These investments range from hundreds of thousands of dollars to hundreds of millions of dollars. They are heavily based in the software industry, but are slowly moving more and more into hardware, consumer goods, biomedical, and more. Most venture firms specialize in one or a few specific areas (for example, B2B software or the gig economy or anything else). Often when you raise a round of funding, you will have multiple investors, but one firm will “lead” the round, contributing the largest amount of money, and they will often also get a seat on your board of directors to be able to then help protect their investment.

Startup incubators or accelerators are unique in that they usually offer a combination of both funding and mentorship in exchange for a portion of the company. Depending on the program, the mentorship may be remote or in-person, and may be individualized or through a cohort program of several businesses that apply and get accepted all at the same time, or some combination. The programs can last anywhere from a few weeks to a few months, and can be full-time or part-time, and focus on helping you learn every aspect you need to make your business successful. They also usually connect you to a rich network of experts, advisors, and alumni both during the program and after. Because of the other aspects they provide, the funding tends to be much lower.

It’s hard to overstate how difficult it can be to get venture funding if you’re not exactly what they’re looking for. VCs are focused on a very specific type of business that they believe has the ability to make hundreds of millions of dollars a year, and do so very quickly.

They’re also inundated with outreach, so you often need an “in”— an introduction or connection in some way, or a reputation that speaks for itself. It’s of course very possible to get conversations with VCs without this, but it’s difficult.

Once you have this, the process can vary and be subjective based on what each firm is looking for—but unless you’re a proven, known quantity already as an individual or founding team, that means the business probably needs to be a proven, known quantity—and that means a launched MVP with customers to show traction.