What is equity financing?
Equity Financing is a method of raising funds from choosing investors for the company’s internal investment to purchasing stocks, inventories, fixed assets like Land & Building, Machinery, etc. In other words, we receive funds by selling shares of the company. Investors are like supporters who perform for the company from the initial stage to meet its startup requirements but in exchange, they expect an authority of making decisions and dividends plus a higher rate of return on investment (around 30 % to 50%).
As an owner of the company, Whenever we move through the beginning of business activities, we think about some initial investment that comes from investors ie. financing but when we sell shares to the public, private individuals, or private corporations ie. equity financing. Without equity financing, we can’t build trust, authority, goodwill, expect profit, and can’t fulfill the operating expenses of our company due to lack of investment.
As everyone knows that today is the era of “give and take” so exactly, the investor invests the money and the company sells the shares to them. In simple words, equity financing is the way of raising capital from investors market through selling of company’s shares. The best part of this equity financing, we don’t need to repay capital and don’t pay any interest. Just like, if companies borrow investment capital from lenders such as banks or other financial institutions, they expect repayment of capital with interest. That’s why companies prefer equity financing more than debt financing, it may have another reason is debt is more risky than equity financing.
By the way, Financing is of two types: Debt financing and equity financing.
Both financings have different rules and regulations to regulate the company’s movement. The company accepts the financial taste of both financing because both are required at a specific time and stage to meet requirements. Financing involves obligations so that the company adopts such financing by satisfying all designed by local and national government policies and securities. Let’s clear the difference between debt financing and equity financing.
Debt Financing Vs Equity Financing
Equity financing is different from Debt financing but the motive is the same to offer funds for the company’s turnover of cash flows to satisfy short-term and long-term needs.
Equity financing refers to raising funds from investors in exchange for the company’s shares. On the other hand, Debt financing refers to raising funds from lenders such as banks, private lenders, friends, or family in exchange for providing interest on the principal amount.
Investors in equity financing have legal authority in the company’s activities such as a part in the decision-making process, ownership control, and known as a shareholder, and authority to receive dividends at a higher rate of return. On the other hand, Lenders have no authority to receive such earnings, and no right to become a part of the decision-making process, they have the right to receive interest at a low rate of return.
Equity financing contains less risk due to ownership. Every investor is responsible for their investment, they can’t blame the company for any loss or damage in the company. It is because the company is not part of any debt.
On the other hand, Debt financing contains more risk due to non-ownership. Under this financing, the company is responsible for all loss or damage then they can’t be liable to pay interest to lenders. It is because the company is a part of a debt which is known as a debtor.
Equity investors depend on their accessible information and past reports of the company so that they can think about investment, not depend on the company’s action or creditworthiness.
On the other hand, Debt investors totally depend on the creditworthiness of the company or individual who is the debtors because they receive interest on the principal amount of loan from the company.
Equity financing takes time to complete all the rules and obligations that combine with local and national securities, that’s why it is a lengthy and time-consuming process.
On the other hand, Debt financing has less paperwork to complete that’s why it is a fast process to raise funds.
How does Equity Financing works
Equity financing has only one motive to meet the needs of the company such as fulfill the business activities, such as resources, expenses, short-term requirements and long-term requirements to achieve goals for high potential growth of business. These investors can invest in the company anytime, to expand their financial growth. Every business owner should not bet on the investor, they should choose the investor according to the requirements of their company and the investor can be anyone.
Advantages of Equity Financing
- Raising funds: For new startup businesses, business owners have a fear of raising funds from such banks as a loan because it consists more of risk on debt financing so companies prefer equity financing for investment. Investors can be anyone such as angel investors, crowdfunding, venture capitalists. If these investors provide capital in the company so they also get a position of shareholder in the company.
- Involved in business operations: Equity financing also facilitates to company’s management by involving in business operations to contribute thoughts, ideas, suggestions for a company’s growth. These investors also wish to assist the company;s management about the production, marketing and sales department.
Types of investors
- Angel investors: These investors are generally your family, friends or relatives who are considered as individual investors, provide capital structure in expecting a high rate of return in investment and also provide some skills, financial experience to the company’s management for better growth.
- Venture capitalist: Venture capitalist is a team of investors in which they provide an amount of capital to the other companies growth in exchange of shares in the company. After investing, they have some rights such as decision making, share in profits, control on management. They receive a higher share as compared to angel investors.
- Corporate investors: Corporate investors are the companies who provide funds only to the private companies in the form of equity financing and get a partnership in the company.
- Initial public offerings (IPOs): Initial public offering offers a shares of corporation to the public in a new stock issuance and it allows a company to collect funds from public investors
- Crowdfunding: Crowdfunding is the platform where people can raise a small amount of funds for a business startup. It is a group of people who work in a team and provide online service through the internet. Everyone can be part of this funding. There are many crowdfunding sites where people can raise capital for any reasons such as business growth or startup, investment in social work, and raising funds for illnesses such as cancer, brain tumor. It is a worldwide process.
How equity financing performs in small business
Equity financing may be good or bad in small business because according to our knowledge, small business does not need more funds for investment but the purpose of getting equity financing is to provide funds so that the company can meet their basic and advanced requirements.
Equity financing is best for small businesses due to the right path and less risk of raising funds from investors. By the way, debt financing has been running for time and most of the owners accept investment as a loan but equity financing also takes the place of debt financing without charging any interest on the amount because equity financing allows the company to raise funds as a capital exchange of shares.