Equity financing is the act of raising working capital for company activities by selling common or preferred stock to individual or institutional investors. In return for the money paid, shareholders receive ownership interests in the corporation.
Equity financing requires that you sell a shareholding in the business in exchange for working capital. The most basic hurdle to overcome when seeking equity financing is finding investors who are willing to buy into your business; however, the amount of equity financing that you undertake may depend more upon your willingness to share management control of the business. By selling equity interests in your business, you sacrifice some of your autonomy and management rights; however you may be able to bring in the equity shareholder as a silent partner.
The effect of selling a large percentage of the ownership interest in your business may mean that your own investment will be short-term, unless you retain a majority interest in the business and control over future sale of the business. Many small business operators are not necessarily interested in maintaining their business indefinitely, and your personal motives for pursuing a small business will determine the value you place upon business ownership. Sometimes the bottom line is whether you would rather operate a successful business for several years and then sell your interests for a fair profit, or be repeatedly frustrated in attempts at financing a business plan that cannot achieve its potential because of insufficient working capital.
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There are two main types of capital ; debt finance and equity finance. They are very different and will therefore have a very different effect on your business as it grows and develops. Many small businesses actually use equity finance without even realising it. Many businesses are launched with either personal capital or that of friends and relatives. There can be an equity arrangement where friends and family take a stake in the business.
The big advantage of equity finance is that it never has to be repaid and there is no interest rate paid on the money. Equity investments are true risk capital as there is no guarantee of the investors getting their money back. The investment is not tied to any particular assets that can be redeemed from the business and, should the business fail, an equity shareholder is less likely to get their original investment back than any other type of investor.
The return from an equity investment can be generated either through a sale of the shares once the company has grown; through dividends, or a discretionary payout to shareholders if the business does well.
However, the reason that firms will give you cash in this form is that they will take a share of the business in return. Formal equity finance is available through a number of different sources, such as business angels, venture capital firms or the stock markets; your financial advisor, accountant, or business attorney will be able to advise in these matters.
The amount of money available and the process of completing the financing package will vary with each different source. For example, business angels are typically looking to write a cheque for a minimum of $50,000 - any smaller amounts are not usually appropriate because the fixed costs are too large. Equity investors are prepared to put up risk capital in return for a share in a growth business. If your business can not support growth rates of at least 20% you may not be able to attract equity funding.
There is a real ignorance about the possibilities of selling shares and because of that ignorance there are fears. Companies usually reinvest the profits or go to a bank for money because it is commonly thought that by selling shares they will lose their interest in the business. However, the rapid growth and capital consumption that these businesses experience will make them unpopular with the banks. Banks, the major providers of debt finance, like to see steady growth projections based upon a watertight business plan. But many companies are still reluctant to seek equity financing as they see it as relinquishing control.
There are many different options available for small businesses. It is "horses for courses". Each business should investigate the options outlined and choose the right business finance for the right purpose.
Equity Financing >>
