Equity Financing and How It Works--A Smart Tutorial!

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Equity Financing is fast becoming the most popular funding method in the global startup sphere. Empirical observations have shown that it can be difficult for many startup ventures to obtain loan or capital through traditional financing methods, and equity financing is often the best—sometimes, even the only—means of raising fund.

Equity financing has been found to be particularly attractive because it affords owners the opportunity of raising funds from investors that are keen on investing huge sums of money and it entails no repayment of funds obtained.

But what really is equity financing?

First off, equity is the representation of ownership interest in a business— any business—allocated to individuals or entities. Equity financing, also known as share financing, involves the evaluation of a business and fixing of a share price and then the sale of these shares to investors.

Raising a round of equity usually takes a lot of time, energy, and resources.

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Startup owners must, therefore, be absolutely sure that equity financing is what they need. This decision is usually based on a number of factors ranging from “which source of funding is most easily accessible for the company, its cash flow, and how important maintaining control of the company is to the principal owners.”

Perhaps the greatest advantage of equity financing is based on the reality that there is no obligation to repay any part of the money raised or a duty to pay interests.

To recapitulate, equity financing is best for business owners that seek long-term corporate investment, funds which they need not pay back, and huge capital required to grow their businesses over a period of time during which profit-making may not come into the picture.

Advantages of Equity Financing

(1) The most obvious advantage revolves around the fact that owners are completely free from the financial burden of having to pay fixed, obligatory dividends or make repayments on loans.

(2)Since there‟s no amortization regime that requires funds to be returned at a particular time, a company retains all earnings and uses it to finance the increased working capital of the company. Consequently, the hassle of raising funds from other sources is obviated.

(3) Investors—often people with vast business experience and contacts—that hold equity stakes in a company bring a lot of valuable experience, networks, credibility, technical and managerial skills to the table. And they do this willingly, knowing that the steadier the company grows, the healthier their investments.

Disadvantages of Equity Financing

(1) Raising funds through equity financing can be a rigorous, costly, and time-consuming process—it may distract startup owners from their core business activities and the entire project may suffer.

(2) A lot of management time is invested into preparing comprehensive background information and in providing regular updates on the business structure for the investors to monitor.

(3) Although total control of the business is not relinquished, startup owners still lose a certain amount of power to make management decisions, depending on how much equity is given out.

References:
James Macon, Principal, Barbour Alliance L3C: “Demystifying Equity Financing”.
https://www.investopedia.com/ask/answers/042215/what-are-benefits-company-using-equity-financing-vsdebt-financing.asp (Accessed on 17 September 2018)