One notable way to raise capital for your business is to pursue equity financing. This blog post will explain how equity financing works and how you can obtain it. In addition, we’ll provide the potential benefits and downsides that come with this funding option.
Equity Financing Definition:
Equity financing is a popular way for entrepreneurs to raise money for their businesses without acquiring debt. In this form of additional capital, the company owner sells shares to equity investors in exchange for cash.It sounds simple enough, but obtaining equity financing is a big decision that’ll affect your business in the short and long term. Before exploring equity investments, it’s crucial to fully understand the process of obtaining this financing source and the pros and cons that might affect your business’s future.
How to Obtain Equity Financing:
When pursuing this type of business financing, you may go to one (or more) of several sources. Common types of equity financing include:
The process for obtaining equity financing differs depending on the funding source. With venture capitalists, you’ll need to show them a business plan that demonstrates a high rate of return for their investment, usually at least 25 percent, but often much more.You’ll also face similar hurdles with Small Business Investment Companies. However, these companies are backed by the SBA, so their qualification criteria are generally less stringent.With other equity financing sources, such as crowdfunding or angel investors, raising funding may be as simple as convincing people that you have a good idea. If they like your business idea, they may be willing to invest in it in exchange for ownership or another benefit.That said, a well-crafted business plan will surely improve your chances of success with potential investors. Also, regardless of who’s investing, you should hire a lawyer to draw up contracts regarding the specifics of your equity financing deal.
The Pros and Cons of Equity Financing:
The Pros of Equity Financing
The primary advantage of equity financing is its availability, short-term affordability, and limited downside risk.Even if it’s impossible for you to obtain debt financing because of your poor credit history, you can still access this type of financing. Therefore, the direct, short-term cost is generally lower than debt financing because you don’t pay fees or interest.Finally, since you pay for equity financing with your business shares, you don’t have to pay your investors back should the business fail.Some people prefer this format to business loans, which enables them to borrow money, but they have to pay it back in set terms. If you’re concerned about making loan payments on time, you may consider other options.
The Cons of Equity Financing
Equity financing has some downsides, most notably the potential to lose control of your company.Since equity financing requires you to give up your company shares, this type of business financing can cause you to lose some or all your ownership and management rights. In fact, this is how Steve Jobs was forced out of the company he built, Apple.In addition, by selling your ownership shares, you’re entitled to a smaller percentage of your company’s profits, limiting your upside earnings potential.As a small business owner, you should be aware of your earning ability. If participating in an equity investment will limit your future financial gain, this might not be your best option for increasing cash flow.As previously mentioned, if you take out a business loan, you’ll have to repay your lender. Although you may be concerned about making loan payments on time, you won’t have to worry about losing control of your business. If maintaining ownership is important to you, pursuing a business loan may be a better fit than equity financing.
Conclusion: Is Equity Financing Right for Your Business?
Equity financing could be a good fit for any business owner needing a significant amount of capital to start or grow.Of course, you must be comfortable with the terms of your equity financing deal, which can vary considerably. In addition, you should be prepared to work with and potentially cede some control of your business to your investors.Due to this, just because your business needs money doesn’t necessarily mean that equity financing is the best funding option for you. However, suppose you find a good deal offered by investors with whom you can have a successful working relationship. In that case, equity financing could benefit your business.Consult a lawyer to draw up documents and review all contracts if you pursue equity financing. A lawyer can explain the legal considerations of different deal structures and draft documents that protect you and your investors.Editor’s Note: This post was updated for accuracy and comprehensiveness in June 2022.