Here are some helpful hints when considering equity funding:

You're giving up the farm

OK, maybe not the whole farm, but at least a few acres! When you give up equity in your company it's rare that you are ever going to get it back, so be very mindful with how you distribute your equity.

For example, if you were to give up 30% of your company for $250,000 in equity, that might not sound like a bad deal, especially if you have no capital to begin with. And maybe it's a good deal. But bear in mind that the 30% you give to an investor will be gone forever.

Now, the next time you need to go to the well to raise more capital, you will only have 70% left over. In some cases an investor may be willing to part with some of their equity to help raise additional capital, but don't count on it. An investor is more interested in keeping their equity once they get it (no surprise, right?)

We're not suggesitng that you horde your equity in spite of the needs that your company has. Far from it. We are simply suggesting that you try to keep the long view in mind. At some point that equity is going to be worth a lot of money, so you want to be as frugal as possible with how you give it up when you do.

It's only worth what someone is willing to buy it for

When you offer someone equity in the business in exchange for capital, that investment is based on some valuation of the company. If I tell you that my company is worth $100, and you invest $50, than it would stand to reason that you would own 50% of the company.

So who determines what a company is really worth? The answer is both of you, but at the end of the day, the investor. Let's face it, if the investor doesn't want to pay the price you've set for the investment, he won't. The investor is ultimately in control of the terms of the investment.

However, it is often up to the entrepreneur to determine what the starting price of the investment will be, or the valuation. There's no way I can possibly cover all the finer points of small business valuation in this section, so let me give you this - in most cases neither the entrepreneur or the investor has an uncontested valuation for a business, especailly a startup company with no revenue.

The fact is most valuations are arrived at when the entrepreneur finds a point that they are comfortable giving up a certain chunk of equity and the investor thinks it's worth thier time and capital to invest for that chunk of equity. Sounds kind if flimsy, doesn't it? It is, but it works, and that's how most equity deals in the early stages of a company are constructed.

Later on, when a company begins to show a specific revenue growth track the investors can begin to get more specific valuations based on past performance. But even then it's just a more educated guess. And you thought it was all secret formulas and MBAs!