What Does Equity Investment Mean?

The most basic equity investment operation is the purchase of a common share. Common shares are pieces of a given business, also known as stocks. These stocks entitle the owner to a certain portion of the profits and assets and they can be bought either privately or publicly, depending on how the company is currently structured.

On the other hand, there are other types of equity investments like preferred shares, stock options and convertible bonds, which are different than common shares since they limit the way the owner participates in the company’s profits or they require certain event to take place before they can be converted into an equity instrument. Also, there are financial companies that offer equity investment securities that serve as a pool of many equity investments.

This is the case of equity mutual funds and ETFs, normally managed by professionals. For investors to engage in this kind of investments they must purchase the mutual fund or ETF shares and that entitles them to certain portion of the overall pool of equity investments.

Example

Jack is a 63 years old retired engineer who’s currently working freelance as an angel investor. His job is to pour funds into promising newly created businesses (startups). Jack has been recently interested in a business proposal he received from Marcus, an entrepreneur who’s working in a way to reduce the amount of paper sheets used by companies through an instant paper recycling machine.

In order to get things moving, Marcus needs $50,000 for research and development expenses. He is promising Jack to have a working prototype if he commits to invest the money. Jack asked Marcus a 35% of his company for the $50,000. That means 35 out of each 100 shares issued by Marcus’ business. This equity investment will be the cornerstone of this awesome project since it will get Marcus the funds he needs to fully develop the product.

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What Does Venture Capital Mean?

What is the definition of venture capital? VC is used to fund a startup when there is a need to grow the business and realize an above-average profit. At this stage, a venture capitalist invests in a firm that has a high growth potential and can generate viable profits in the long-term.

Usually, venture capitalists invest their money in firms that have limited or no access to capital markets, thereby fueling their core operations while leveraging risk. From the business owner perspective, the downside is that venture capitalists are free to state their opinion and require changes in the company so that it becomes profitable and they are not losing the invested capital.

Let’s look at an example.

Example

Andy is an investment manager, and he is involved in VC funding. He likes to invest in relatively high-risk companies with a high growth potential, in spite of the size. He has participated in the funding of small caps, up to $2 billion, but also to mid-caps with funds that exceeded $3 billion. Normally, his investment horizon is 5-7 years during which Andy expects to realize a high return.

The potential for above-average returns is what keeps Andy funding different companies. Moreover, he manages money that he can pool from third parties, such as people who have a lot of money and are interested in becoming limited partners to small or medium-sized startups.

Usually, Andy invests at the development stage of a company. Funding a company at its early stage is not intriguing for him because the company is not 100% developed. The capital required for funding a company at the early stage may cover the market research, the establishment of legal frameworks for investors, and so on. Conversely, funding a company at the development stage allows a comparison with similar companies that operate in the same industry. At this stage, or in the acquisition stage, Andy can request a certain percentage of ownership to the company and participation in the board of directors, therefore, having a say about the future steps of the company.

Summary Definition

Define Venture Capitalist: Venture capital means the funds used to invest in new businesses that have a high likelihood of growing drastically in the near future.

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What Does Angel Investors Mean?

What is the definition of angel investors? These investors participate in the funding of a startup company because they believe in the business idea or in the person who invented it and they offer a one-time investment to get the business moving. Alternatively, they may fund a business on an ongoing basis, especially if there are hardships at the early stages.

Besides funding the business in significantly better terms than a bank or other lender, an angel investor offers expertise and a valuable network of contacts, seeking to see the business propel. Angel investors should be accredited by the Securities Exchange Commission (SEC) and realize an annual income of $200,000, on top of a minimum net worth of $1 million. In this context, angel investors may be individual accredited investors or an investment fund, business, etc.

Let’s look at an example.

Example

Alexander owns an investment banking firm, and he is interested in investing in his friend’s Jonathan startup technology company. He can provide $500,000 as initial funding, and he will acquire a 25% stake in the company. Unlike venture capitalists, who invest and manage funds pooled for different resources, Alexander is an angel investor who believes in the business idea and invests his own funds. Also, he is a member of an angel investor group, which consists of similar entrepreneurs who share the same interests and share investment ideas and relevant research.

Jonathan is excited that Alexander will participate in the company, and he doesn’t mind giving up 25% of the equity. Alexander has a great network from which he can pool potential customers, and he is also an experienced entrepreneur who knows how to turn things around, especially during tough financial times. Before contacting Alexander, Jonathan had sought to raise debt from a local bank, but the interest rates were high, and the bank’s credit line policy was quite strict. So, he thinks that turning to angel investing will help his business propel and generate revenue.

Summary Definition

Define Angel Investors: Angel investor means a person who contributes money to a company, usually a startup, in hopes that the company will grow and their original investment will increase dramatically.

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