Rather than racking up debt to finance your business, you can give ownership in exchange for the money you need. Learn what forms of business and what equity financing options can work best for your business.
Equity Financing:
Equity financing means the sale of company shares in order to raise capital. Purchasing the shares also gives the ownership rights of the company to the investor. It can also refer to the sale of all equity instruments, such as common stock, preferred shares, share warrants, etc. Equity financing is especially important for a company’s startup stage to finance plant, assets and initial operating expenses. Investors make profits by getting dividends or when their shares price increases. Equity financing may come from friends, family, professional investors, or an initial public offering (IPO).
The amount of equity financing that you hold may depend more upon your willingness to share the control of management than upon the investor’s appeal of the business. And by selling equity shares in your business, you are sacrificing some of your autonomy and management rights.
Sources of Equity Financing:
If the company is still private, then there are many sources that allow for equity financing from angel investors, crowdfunding platforms, venture capital firms, or corporate investors. Finally, shares can be sold to the public through an IPOs.
1. Angel Investor:
Angel investors are wealthy individuals who purchase stakes in businesses because they believe there is potential in those businesses to generate higher returns in the future. These individuals generally bring their business skills, experience, and connections to the table, which helps the company in the long term.
2. Crowdfunding platform:
It is a platform that allows a number of people in the public to invest in small amounts in the company. There are Members of the public who decide to invest in the companies because they believe in their ideas and hope to earn their money back with good returns in the future. Contributions from the public are totalled up to get a target total.
3. Venture Capital firms:
Venture capital firms are investors who take their money and invest it in companies that they feel will gain at a fast pace and will be featured in the stock exchange sometime in the future. They invest more money into businesses and are given a bigger stake in the company compared to an angel investor. The process is also called private equity financing.
4. Corporate investors:
Corporate investors are the big firms that invest in the private firms for offering them the much-needed capital. An investment, generally, is created to develop a strategic partnership between the two businesses.
5. Initial public offerings (IPOs):
Companies that are well-established can raise funding with an initial public offering (IPO). The IPO allows companies to raise funds by offering its shares to the public at large for trading in the capital markets.
Equity Financing for Small businesses:
The biggest merit of equity funding is that the money doesn’t have to be paid back, only a share of profits has to be paid. Means, in case your business does not work well, you won’t have to repay the investors. Equity financing is quite useful when other funding strategies are not practical or the amounts are too small. Also, if you can’t bootstrap or there is a requirement of lots of fund in business, then equity funding is a viable option. There is one more benefit for the startups or small businesses that they can value their company based on the potential of the company, such as forecasting profitability based on growth.
Advantages of equity financing:
1. Less Liability:
No loan payback or any instalment, only you need to share the profit with the investors.
2. No credit problems anymore:
If you do not have a good credit-worthiness, even because of a bad credit history or for not having a financial track record, equity financing may be better than debt financing.
3. Learn and get from partners:
With equity financing, you will also be giving yourself an opportunity to unofficially partner with more sophisticated or experienced people or organizations. At times, these people are well-connected, and the business will benefit directly from knowledge and business connections within your lines of work.
Disadvantages of equity financing:
Share profit:
Your investors will expect – and deserve – a share of your profits. But it can be a fair trade if you are benefiting from their worth as a source of finance and/or their business expertise and experience.
Loss of control:
The price for equity financing and all the potential benefits that you can derive from it is that you have to share control of the company.
Potential conflict:
Co-ownership and the issues of having to work with others can create tension or even outright conflict because a different vision, management approach, or business approach is in place. Something that could be seriously taken into consideration.
Conclusion:
The greatest challenge of equity financing is when you convince the investors that your business is worth their money. Ensure that you have a watertight business plan and proper firm handle on costs, income, market trends, and challenges, especially in terms of financial forecasts. You should know what the future holds for your business.
Equity financing can raise huge capital to encourage rapid and greater growth, making the company attractive to buyers and sale possible. The merits of using equity financing or debt financing depend on the amount of money needed and the size of the business. Most firms combine the two forms of capital: debt and equity. However, the greater percentage of equity as compared to debt means safety is implied.