Every deal is different, but here are some basics.
There are three main ways investors can provide funding to your small business: equity investment, debt investment, or convertible debt.
With equity investment, an investor will buy an ownership stake in your business. For instance, an investor might provide $100,000 in cash for a 10% ownership stake, meaning they will receive 10% of whatever profits you make down the road.
Debt investment is different in that an investor loans your venture money in exchange for eventual repayment of the loan, plus interest income. Debt capital is most often provided either in the form of direct loans with regular amortization (reduction of interest first, then principal) or the purchase of bonds issued by the business, which provide semi-annual interest payments mailed to the bondholder. Debt investment is considered less risky for the investor. If your venture fails, debt investors recoup their investment before equity investors. However, debt investors also have no ownership stake, meaning if your business is wildly successful, they won’t see the same escalating profits that an equity investor will.
The third option, convertible debt, is a hybrid of debt and equity investment. Your business borrows money from investors under the agreement that the loan will either be repaid or turned into an ownership share at a later point. This conversion typically takes place after an additional round of funding or once your company reaches a certain valuation.