What is Equity Financing? How Can It Benefit Our Business?
Equity financing is a usual topic of conversation for an entrepreneur or businesses going public as to how a business can get funds. It can be valuable for small businesses that require additional startup funds to scale faster and reach their business goals through funding. These funds can help grow your business, but it also comes with risk. To better learn how to raise equity financing, we’ll be breaking down the basics of equity funding, and funding sources available.
What is Equity Financing?
Equity financing is the means of raising capital in exchange for ownership of shares in your business. It allows you to raise enough funds without incurring any debt such as a credit card or bank loan. It is usually used as a short-term approach for raising capital especially when you lack the working capital needed to launch your latest product or service. You can get equity funds in the form of Initial Public Offering, Venture capital, Angel Investors for Equity Funding, Mezzanine Funding, Royalty Funding, and Equity Crowdfunding. I will briefly discuss these sources of equity funding in the next section.
Read also: 5 Types of Business Financing. How to Avail Them?
When to Use Equity Funding?
This is a question that various businesses face. Some believe that the best time to begin searching for investors is when they have already raised a lot of money. Others believe that it is better to bank the funding and wait until their business is at the next stage of development. At the end of the day, you have to decide what is more suited to your needs and if you should borrow funds to build working capital. Equity funding is not always right for every business and it is, in any case, a must to do your analysis on all the equity funding choices.
To help you decide which route is right for you, here are a few reasons in which it can be used:
To Sell Your Business and Expand Your Operations
When your business is at the stage of development, you have a plan for growth that needs a considerable amount of capital and you want to put it up for sale. You can sell your shares the way you want. If you already have an investor, you can concentrate more on the future of your business like diversifying your operations and your long-term plans. Building funds through this funding can help you accelerate your business progress and become appealing to your possible consumers.
To Manage Your Business Debt
Equity funding can maintain your current balance sheets while adding resources to your operation. Investors also take on risks in equity funding. As a result, your debt becomes stable because of the shared responsibility for your board to address. Investors focus on long-term investing, so you do not have to worry about repaying monthly fees. Thus, it increases not your business debt but the revenue.
To Build Beneficial Connections
You can connect with business professionals that can serve as an advisor to your small business. Angel investors and venture capitalists usually have the experience, especially in developing startup businesses. Not to mention, being part of their portfolio companies allow you to connect with the management or C-suite individuals in their communities. You should have trust because investors can help you learn their connections, new strategies, and ideas. Of course, their main focus is to assure that your business will succeed so that they can also have better returns on their investments.
Does Your Business Funding? Know important things here before getting a business funding
How Does Equity Funding Work?
Funding through private equity firms or investor is a good alternative. They can give extra resources and may contribute in a form of management advice. This funding can be used in many steps of your business, whether you are just starting or an established business looking for progress. Finding equity investors may require significant effort, time, and money. It includes providing important documents and presentations, gaining interested parties, pitching, and onboarding the equity investor. With the right private investor, you will not simply generate enough cash flow but also the skills and connections to direct your business forward.
6 Sources of Equity Funding
There are many sources for equity funding. The amount of equity funding you can raise will vary depending on your circumstances. These are the sources that you can use to raise equity funding for your startup or growing business.
Initial Public Offering
Initial Public Offering or IPO is a method that lets you raise capital by offering common stock to the public while still keeping your company’s equity and preferred shares. You can use this method to raise capital from the sale of the shares and take advantage of a higher price or valuation. It is used to raise your business profile, extend publicity, and attract public investors. This however is a time and cost-consuming process if you are a small business owner as you might unlikely be able to find investors, but the practice of listing your stocks for sale publicly requires a lot of tedious accounting to pass regulations.
Angel Investors for Equity Funding
An Angel investor provides personal funding for businesses. These business angels are wealthy individuals or organizations who are searching for better returns on their investments. Angel investors also contribute technical, operational knowledge and may give another set of funds after their initial funding.
Mezzanine Funding
It is a combination of debt financing and equity funding. It gives the lender the right to convert the debt funding to an equity interest. In this method, you can get the funding very easily with less or no due diligence and the lender provides the fund with insignificant collateral securities. With mezzanine funds, the lender can set terms such as the record of financial gains which is a requirement for funding your business.
Venture Capital
Venture capital firms provide funding in exchange for ownership, or shares, of your business. A venture capitalist do not use their personal funds for equity investment. These firms consist of a group of professional investors with cash holdings to invest in a start-up or growing business to support your business growth. If you want to consider venture capitalists, you have to look for a financial institution that is interested in your line of business.
Royalty Funding
Royalty funding is known as revenue-based funding. It is different from angel investors and venture capitalists because you have to establish first your sales before you can get approval. In royalty funding, investors expect that they can immediately receive payments based on the contract. It can give advance funds for your business expenses in return for a portion of the revenue received from your product.
Equity Crowdfunding
A method of raising capital from your business securities to potential investors in exchange for funding. Each investor is qualified to receive a share in the business equivalent to their equity investments. Examples of these crowdfunding platforms include OurCrowd, AngelList, and CircleUp.
Equity Funding: Advantages and Disadvantages
There are different funding sources and funding strategies, and they all come with their own advantages and disadvantages. Different types of private equity funds has its own terms and guidelines that you must follow. That’s why it is necessary to understand the ins and outs of these sources.
Advantages
Equity finance suggests low-risk funding that authorizes you to trade a part of your ownership to investors so that you can focus more on your operation. Investors through equity finance usually concentrate on the long term without expecting quick gains from their investments. So, it allows you to reinvest the cash flow from your business operations to improve rather than being pressured on the repayment of your debt.
You are not required to pay interest fees to your investor’s initial investment. Although you have to allocate some of your profits as dividends to your investors. It can also help you to gain more profit and adaptability on spending for your business. In doing so, it allows you to gain from their investments without going into debt.
Disadvantages
Equity finance can be a long process because you need to spend time to find the right investor for your business and develop a business plan to present to your potential investors. This covers consulting the terms of your deal and completing the final legal papers required while running your business.
With each share you sell to your investors, you reduce your ownership stake in your business. Then, your investors have the right to vote on significant business decisions. Thus, you can potentially lose control of your business if you sell too much stock. Most investors invest in a business if they are sure that they can make a profit. When you receive significant investment from your investors, it will very likely come at a huge cost over time.
Final Thought
Personally, I do not appreciate giving away equity, as you can lose control of your business. Giving equity to the wrong person or entity also means that they get to benefit from your efforts when their investment in you may not be substantial enough to support their compensation. This can lead to added stress and sometimes even loss of desire to continue growing the business. This is important to take note of especially when you are emotionally attached to your business or are actively putting in the effort and funds to grow it.
However, selling part of your business that is already matured is a great way to cash out your investment as most buyers may not be keen to take over your entire business immediately as they may be wary of any information not presented to them during the purchase process.
