In this blog we already discussed how to put together the financial model of your start up business - how to model revenues, investments and different cost categories. That part of the financial model represents the operational aspect of your business. But in order to turn your plan to a successful start up business, you have to find the ways how to finance your ideas. In general, you have 2 sources of finance - equity (the owners' stake in the business) and debt (outsiders' financing that have to be repaid). Today we will talk about tips and tricks of modeling equity financing in your financial model.

How to model equity in your start-up financial plan

1. What can be the source of your equity financing?

In early stage start up companies, the sources of finance are limited. First money that you invest into your business are likely to be your own savings or money borrowed from your family and friends. You can even get a personal loan and invest that money into the equity of your business. All these sources are, however, limited, and as your company will grow, you will have to look around for additional equity funding. One way is to re-invest the money your business earns back into the company, but in case of rapid growth, this may not be enough. At this point you will likely seek investments from seed capital, angel investors and later from venture capital firms who invest money into start up companies with a potential to scale up and grow. You can also look for private equity investors and issue private stocks. Finally, if you survive the development and growth phase, you can bring your company to stock market and issue your first stock in initial public offering.

2. How to slice different equity issues?

Different tranches of equity issued at different life-cycle stage of the company are typically denoted as Series A, B, C, etc. or Round 1, 2, 3, etc. The first round of share or equity issues occure at the very early stage of the company, when the business needs money to finance its product and business model development. In the next round, the company need to raise extra money to fuel its growth, expand the product base or enter new markets. In each next round of equity financing the company raises more money to finance its growth and development until the eventual initial public offering.

3. How to model equity financing in Feanut Financial Model?

Feanut Financial Model has a separate section for modeling the equity financing. It allows you to populate individual rounds of equity financing with specific details, such as the date of share issue, number of shares issued, price per share, end eventually the dividend paid. You can also differentiate between common shares (shares that have all the shareholder's rights) and preferred shares (shares that have a preferential treatment in paying dividends, but have limited ownership rights). The model has also a section for share buy-backs. Sometimes the companies buy their shares back, for example if they have excess cash and wants to change the capital structure more in favor of debt capital. Or in a case when preferred shares were issued and the company wants to buy them back to save money on dividends (preferred share tend to pay higher dividend).

4. How to think about modeling your equity finance?

When you will be modeling your equity financing, think about the amount of money that you need to invest into your business at different stages. You should already have your financial plan in place for your revenues and costs, so you should have a clear picture on how much money you will need in different periods. Start with the first round to cover the entry phase and then plan each next round of equity financing according to your cash needs to invest into new assets and to invest into growing production. Remember that you can also use debt financing to fuel your growth. Although access to debt financing will be very limited in the early stages, later you can raise more money as debt, which is cheaper than equity and allows you to leverage your income. Don't plan to raise significantly more capital than you will actually need in different periods, as that will increase your financing costs.

In addition, consider whether to pay dividends or not. Many start up companies do not pay dividends on their shares to avoid cash out-flows from the company in critical growth stages. Instead they motivate the investors to buy shares that will grow in their value as the company grows. You can change that in later periods and start to pay out dividends when some growth milestone of your company is met. If you also want to attract investors seeking dividend returns, you can add preferred shares into your equity mix, that will pay dividends, although this option is becoming less popular.

Want to know more about building financial model for start-ups? You can still use the offer to join our Startup financial modeling online course with a discount for first 100 students.