Equity Financing Made Simple: What You Need to Know
When it comes to making the decision to finance your business there are a variety of different paths that you can take, each with its own advantages balanced with disadvantages. The first choice that you may have to make when seeking to fund your business, and what will ultimately determine the funding options available to you, is whether you prefer to finance your business through equity financing or debt financing.
This question can often be a daunting one to answer, as it can have repercussions later on down the line and can shake the foundation of your business along with the established hierarchy. In order to make the best decision, let’s take a deep dive into what equity financing is and how it can help or hinder the future of your enterprise.
What is equity financing?
Equity financing is a method of raising capital for your business by selling a percentage of your ownership, in the form of shares, to investors. In equity financing, investors provide funds to the company in exchange for a percentage of ownership, also known as equity, in the business.
Equity financing can be used by both startups and established companies to raise capital for various purposes, such as expanding operations, developing new products, or paying off any debt that the company may currently owe.
The investor, or investors, who provide equity financing typically receive a share of the profits, known as dividends. They may also have a say in the company’s decision-making process, depending on the terms of the agreement.
Equity financing can be directly contracted with debt financing, where a company borrows capital from lenders and pays it back with interest. Unlike equity financing, debt financing does not involve selling ownership shares, and lenders do not have a say in the company’s decision-making process.
Advantages of Equity Financing
When it comes to utilizing equity financing, your business can benefit in several ways. For instance, the key advantage is that there is no debt repayment. This reduces the financial burden on your business and allows you to focus on growth and expansion, however, there is still a great cost to accessing the capital through relinquishing a certain percentage of ownership in the enterprise.
Equity financing can also come with access to specific expertise, as equity investors can bring valuable insights, experience, and connections to your business which can assist in the growth and success of your company. The expertise offered can greatly carry through and this benefit is stringent on ensuring that you bring the right person on board.
There is also a lower financial risk since equity financing does not require collateral or personal guarantees. Equity financing can also come with a certain degree of flexibility in terms of how your funds can be used as there are no restrictions tied to the capital that you have accepted in exchange for a piece of your business.
Disadvantages of Equity Financing
While equity financing can seem like a great option for your business, it is imperative that you weigh the repercussions of going down this route to obtain capital. Like any financing option or tool, there are hindrances that you should consider before embracing equity financing.
By selling ownership shares through equity financing, you dilute your ownership in your company. This means that you give up control over the decision-making process and may have to share your profits with the investor.
While you do not have to pay back any funds acquired through equity financing, this option can actually come at a higher cost and is typically more expensive than debt financing. Investors expect a higher return on their investment to compensate for the risk involved by injecting their capital into your enterprise.
Equity financing can also be a time-consuming process, as it involves finding investors, negotiating terms, and completing legal and regulatory requirements. At any time during this process, your deal could fall through and you would be back to square one with no funds to show for your time and effort.
There is also a risk of conflict when embracing equity financing. Equity investors may have different goals or expectations for the business which can conflict with your original vision for your enterprise. This can lead to conflicts with the management or any other investors that you may have.
Sources of Equity Financing
When it comes to embracing equity financing there are a number of different avenues to explore. These options can include but are not limited to:
Angel Investors: These are high net-worth individuals who provide capital to startups and early-stage businesses in exchange for ownership shares.
Venture Capital: Venture capital firms provide financing to start-ups and high-growth businesses in exchange for equity. They also provide guidance, resources, and expertise to help your business grow.
Private Equity: Private equity firms invest in established businesses with a proven track record of success. They typically take a more active role in the management of the business and may require a controlling stake.
Crowdfunding: Crowdfunding platforms allow businesses to raise capital from a large number of individuals through online campaigns. In exchange for their investment, investors receive equity in the business.
Initial Public Offering (IPO): An IPO is the process of offering shares of a private company to the public through a stock exchange. This allows the company to raise capital by selling ownership shares to a large number of investors.
Friends and Family: Businesses can also raise equity financing from friends and family members who are willing to invest in the company in exchange for ownership shares.
Each source of equity financing has its own advantages and disadvantages, and businesses should weigh their options carefully before deciding on a financial strategy.
Steps To Equity Financing
When it comes to equity financing, there are a lot more steps compared to debt financing when trying to acquire funds for your business. Below are some of the general steps involved in equity financing, however, these steps may vary depending on the source of the financing.
Prepare a business plan: Before seeking equity financing, a company needs to have a well-prepared business plan that outlines its goals, strategies, and financial projections. This plan will be used to pitch to potential investors.
Determine the amount of capital needed: The company should determine how much money it needs to raise and what percentage of ownership it is willing to sell to investors.
Find potential investors: The company should seek out potential investors, such as venture capitalists, angel investors, or other private equity firms, who are interested in investing in the company.
Pitch to investors: The company will pitch its business plan and financial projections to potential investors, providing them with information about the company's market, competitive advantages, and growth potential.
Negotiate terms: If investors are interested in investing, the company will negotiate the terms of the investment, such as the percentage of ownership the investors will receive, the price per share, and any other terms and conditions of the investment.
Close the deal: Once the terms are agreed upon, the company and the investors will sign a contract, and the investors will transfer the funds to the company.
Use the capital: The company will use the capital raised through equity financing to fund its operations, expand its business, or pursue other growth opportunities.
Provide updates to investors: The company will provide regular updates to its investors about its performance, financial results, and any other important developments.
Equity Financing Terms and Conditions
Like any funding option, it is important to understand the terms and conditions associated with your deal to ensure that you have a thorough understanding of what your business is agreeing to. The terms and conditions associated with equity financing can vary depending on the specific deal negotiated between your company and the investors. Here are some of the common terms and conditions associated with equity financing:
Valuation: The valuation of the company is a key term in equity financing, as it determines the price per share and the percentage of ownership the investors will receive in exchange for their investment.
Investment amount: The amount of investment, or the total capital raised, is a key term in equity financing. This amount can be determined by the company's needs and the amount of interest from investors.
Dividends: Unlike debt financing, equity financing does not typically involve the payment of regular interest payments. Instead, investors may receive dividends, which are payments made to shareholders based on the company's profits.
Board representation: Investors may negotiate the right to appoint a member or members to the company's board of directors in exchange for their investment.
Exit strategy: Investors will typically seek to exit their investment at some point in the future, such as through an IPO or a sale of the company. The terms of the exit strategy may be negotiated upfront.
Dilution: As the company raises additional rounds of equity financing, the ownership percentage of existing investors may be diluted. The terms of dilution and how it will be managed can be negotiated upfront.
Information rights: Investors may negotiate the right to receive regular updates and financial reports from the company to stay informed about its performance.
Anti-dilution protection: Investors may negotiate for anti-dilution protection, which protects their ownership percentage in the company if the company raises additional rounds of financing at a lower valuation than their initial investment.
Is Equity Financing the Solution For Your Business?
When it comes to equity financing, only you are going to be able to decide if this is the appropriate funding option for your business. While equity financing is a great way to receive a capital injection without having to pay it back, the cost of capital is not free and could end up costing your business much more in the long run.
Each partnership will vary and it really comes down to who you decide to work with. Different investors will want different percentages of shares in your company and some may be more hands-on than others.
If you wish to hold control of your business while still acquiring funding for your enterprise then debt financing may be a more appropriate option. While you will be required to pay back what you have borrowed, you will continue to hold control of the business that you worked so hard to start.
Keep Your Equity with Backd’s Debt Financing
Backd specializes in providing debt financing to business owners with flexible terms and competitive rates so that they can grow their businesses the way they want to.
With working capital advances of $25K up to $2M and terms ranging up to 16 months or business lines of credit ranging from $50K to $750K and terms of 6 or 12 months, Backd is positioned to help you expand your business without relinquishing control.
Don’t sacrifice your equity to get the financing that you need. Apply with Backd today!
