What is Equity Financing?
Companies need capital to grow, and they can get capital by either taking a loan (debt financing) or by selling an ownership stake in their company, ie. equity financing. The investors who then own equity in the company get a share of the profits too as the company grows and even bear the losses if the company doesn’t do well, hence there is an inherent risk as well. By the same reasoning, the amount of money invested by the owner in his/her company shows the faith the owner has in his company and is a positive sign and also helps attract investors. For small companies friends, family, and sometimes even angel investors step in with capital in exchange for equity. Large corporations, venture capitalists, large investment firms, and even IPOs do the job. From a recent example, Facebook’s investment of $5.7 billion in Reliance for 9.99% ownership is equity financing.
Deciding if you should go down the equity financing route -
As a company, it is important to keep the debt-to-equity ratio in check. A company cannot mount too much debt nor can the owners give up too much equity in their company. Here are some pros and cons of picking equity financing to help the decision:
- You are not personally liable for the money invested in your company. Whereas, in the case of debt, you personally owe money to the loan issuer.
- It is also easy on your balance sheet as you’re not bound to pay any EMIs for your loan payment.
- If your company goes under you won’t be liable to pay any money to your investors. In the case of debt financing, a bank will still recover its money.
- Getting high-profile investors on board might get access to certain networks which could be really beneficial for the business and its growth.
- Investors can be a double-edged sword. For every decision, you may have to weigh in the opinions of your investors which might result in you not having enough control or independence regarding decisions for your company. On the other side, banks do not have any say in the decisions for your company.
- Finding the right investors can be tedious and time-consuming and often loans can be a faster option if the need for capital is urgent.
- While investors shoulder losses, they also have a share in your profits.
- Investors can often be time-consuming, giving regular updates to them on how their investment is doing, calls, and meetings with investors all take up valuable time.
Types of equity financing -
Now that you’ve decided to fund your company by giving away equity, depending on the investor and how the transaction is carried out, various types of equity financing are:-
- Venture Capital: Venture capitalists are professional experts and often highly experienced. Their investment decisions are a result of careful analysis of the company and the market they’re investing in. They invest more than a million dollars and take an active part in the management of the company they invest in. Their investments are often at the early stages of the company and exit the investment when the company goes public.
- Angel Investors: One major difference between a VC and an angel investor is the amount of money invested, which is significantly smaller than a VC. They generally don’t get involved in the day-to-day operations. Investors or even your family and friends can be angel investors in your company. Whenever you approach an investor make sure you’ve done your research and that the investor might be interested in your market.
- Crowdfunding: You’ve heard of platforms like Kickstarter and Indiegogo, they are crowdfunding platforms. As the name suggests it’s a group of angel investors who pool together some capital to invest in the company. The individual contributions could often be as low as $500. Crowdfunding is a highly regulated space and legal in only certain geographies.
- Initial Public Offering: When companies grow big it often happens that banks, individual investors, and firms don’t have the means necessary to fund the growth of a company, this is when it is a good idea to go public, ie. get listed on the stock market by an IPO. This form of equity financing comes at a very later stage in a company.