Equity financing is when a business owner raises cash reserve by selling business shares. When selling shares in their company, the owner of the business earn capital, which they can leverage to expand the business. Take note that this is entirely different from debt financing, wherein business owners borrow money from creditors while keeping total ownership.
Creating and establishing a business can be costly. Although some business owners can cover various startup expenses with their money saved, not all startup business owners can do so.
When financing your startup business on your personal savings is not feasible; generally, you have two options: equity financing and debt financing. If you have no idea how to fund your business, this post will walk you through the important options to consider. For a little help, here is everything you need to know about equity financing. Read on!
What Is Equity Finance?
If you are just starting to learn the world of small business ownership and entrepreneurship, you’ll be faced with lots of confusing financial terms. However, the term equity financing may mean more to you.
What is equity finance? It is a method of securing capital for your startup by selling several business shares. Every business share sold signifies a unit of company ownership. For example, if the business supplies two thousand shares of common stock, and the company owner has a thousand shares, then the owner owns half of the business.
Any financiers submitting capital for your business will do so in return for shares in your business. By that we mean, the other 50 percent of shares are issued among your investors. The amount of equity or ownership investors offer to your company typically corresponds with the capital they’ve put into your business.
In other words, when investors put money in your business, they become shareholders of the company.
There are different kinds of equity financing investors. The following are a few:
- Angel Investors: Rich people who dive in or invest in promising, early-stage businesses.
- Crowdfunding: With this type of equity investor, you present your business ideas on crowdfunding platforms. Then, investors who visit the platforms can opt to put money in your business notion if they think it’s promising.
- Venture Capital Firms: Similar to angel investors, but more. Meaning, you will be working with a whole company committed to exchanging equity for capital.
Advantages and Disadvantages Of Leveraging Equity Funding to Expand Your Business
What benefits could you receive when using equity financing? Also, what are the reasons why you must avoid equity financing? The following are the advantages and drawbacks you must consider before getting into an equity funding agreement:
One advantage of using equity financing is that it does not require repayment. In debt financing, you need to repay the creditor you work with as well as the interest. Relying upon the loan type you take, you begin repaying the creditor with standard payments.
For medium-term loans, this may be monthly payments, and with short-term loans, this might be daily payments or weekly payments. On the other hand, equity financing does not come with repayments.
Since you have given equity in your company, the investor is repaid through earning future profits. We’re not implying that repaying financing is a bad thing. However, the lack of this requirement might do good for startup business owners.
Moreover, in equity financing, you will gain helpful business advice. Chances are, your equity investor has been in the industry for a long time. Either they had invested in several ventures before or started their own companies.
As equity shareholders in your company, they may have gained voting power in your organization. Meaning, they can share their knowledge with you, helping you get in the correct path. The best thing is that you may have obtained a valuable business advisor and partner via equity financing.
Lastly, another advantage of getting equity financing is that equity investors usually put considerable amounts of money in companies they work with. It can be a significant advantage for companies that must invest in their business and hire different teams to be successful.
One of the most significant drawbacks of equity funding is that you will lose some shares of your ownership. Whenever you dispense shares to equity investors, your business ownership gets diluted. Meaning, any profits or income of your company in the future will not be completely yours.
Another downside is that equity investors will have control over your business. Moreover, not many companies will be examined and appraised. Since equity investors are putting money in businesses, they will only want to invest with high-potential businesses.
Is equity financing appropriate or ideal for you? Well, it can be a brilliant move to take equity financing for most businesses. However, the resolution must not be taken for granted. Before deciding to get equity financing, thoroughly learn the agreement you are dealing with the investor.
If you only need capital and don’t care about having the wisdom of equity investors, then it may be better to take debt financing.