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Equity Financing

Balancing that fine line between accepting capital and losing control

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Because equity financing involves trading partial ownership interest for capital, the more capital a company takes in from equity investors, the more diluted the founder's control. "The question is how much management you're willing to give up," says attorney Jerry Friedland.

Friedland emphasizes the importance of voting control in the company. Investors may be willing to accept a majority of the preferred (nonvoting) stock rather than common (voting) stock. Another possibility is to give the investor a majority of the profits by granting dividends to the preferred stockholders first. Or, holders of nonvoting stock can get liquidation preference, meaning they're first in line to recover their investment if the company goes under.

Even if they're willing to accept a minority position, financiers generally insist on contract provisions that permit them to make management changes under certain conditions. These might include covenants that permit the investor to take control of the company if the corporation fails to meet a certain income level or makes changes without the investor's permission.

Excerpted from Start Your Own Business: The Only Start-Up Guide You'll Ever Need