264 ENTREPRENEURSHIP
Equity-Based Financing
The liabilities and equity side of the balance sheet lists the general types of financing. On
the balance sheet, they are listed in ascending order of risk—and therefore cost—to the
investor. We begin from the bottom of the balance sheet with equity capital and move
up to the less risky and cheaper types of financing.Inside Equity. Financing based on an ownership stake in the new venture is called equi-
ty. All businesses require equity. Initial equity most frequently comes from the founder,
the top management team, and their friends and relatives. Founders traditionally make
personal equity investments commensurate with their financial means. They do this for
a number of reasons: Their own money is easiest to obtain, putting up money shows fu-
ture outside investors the entrepreneurs’ level of commitment, and it offers the right
incentives to business owners. It is almost imperative that people put up their own
money to start their businesses because it proves that they are serious and that they have
put something at risk. This is the basic source of start-up capital for entrepreneurs. How
much of their own money are they prepared to invest in their business?
This is a complicated question. On the one hand, they should be prepared to invest
everything so they don’t send the wrong message to other investors. If the entrepreneurs
hold back, investors might perceive a lack of confidence in the venture’s success. On the
other hand, it is unreasonable to think that starting a business means that an entrepre-
neur’s financial future will be “all or nothing.” Founders should keep a reasonable
amount of capital out of the business, safely set aside to protect their families and them-
selves. The amount held in reserve depends on the situation, but it is reasonable and fair
to set aside money for the following:- Children’s education
- Retirement accounts (depending on age)
- Health savings accounts and insurance
- Home equity (depending on the size of the home)
- Amortization of previous personal debts.
In fact, however, it is not unusual for entrepreneurs to put all of their financial assets at
risk in starting a new venture.
Their next step is to approach the people they know best and who know and trust
them—family, friends, and other “true believers” (sometimes referred to as “fools”).
These folks may be relatively unsophisticated investors and are less likely to demand to
see a business plan. They may be willing to invest despite the apparent lack of an exit
strategy to get their money back, and they frequently require less than market-adjusted
risk rates of return. A book on investing strategy would recommend that these investors
act more professionally, but they are by definitionnot professionals. This is the most
popular source of financing in the United States and probably the most popular in the
world.
Take the case of Matthew Oristano, the CEO and major shareholder of People’s
Choice TV of Shelton, Connecticut. This $25 million wireless-pay-tv company strug-
gled for eight years to secure the financing it needed to make a big impact in the indus-