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equity financing
Finance

What is equity financing? EXPLAINED

The estimated reading time for this post is 188 seconds

Traditionally, there are 2 ways to finance your business or startup. You can either finance your business through debt financing or equity financing. This article will be focusing on equity financing.

Equity financing involves selling ownership of a company to investors for cash to raise money for long term expansion or short term responsibilities like paying bills. In return, if everything goes well for the company, investors will have the opportunity to make high returns.

The main advantage that equity financing has over debt financing is that there is no need for any loan repayment. This makes equity financing the better financing option, especially when your business is still brand new as your business may not be generating much profit yet.

This would allow you to focus more on business growth. Plus, if your business fails, there is no need for you to pay back the initial investment.

However, there are also some cons to equity financing. Through equity financing, investors are entitled to some of the business profits and control over the company.

Sources of Equity Financing

Now that you have a basic understanding of what equity financing entails. Let’s take a look at some sources of equity financing.

IPO (Initial Public Offering)

Initial public offering or IPO basically means that a private company issues out shares open to the public. The shares would then be available in the publicly-traded market, like the New York Stock Exchange.

Thus the company will no longer be a private company but a publicly-traded company.

Advantages and disadvantages of going IPO:

Advantages:

  • Generates a huge amount of capital
  • Boost up the company’s share price
  • Strengthen the company’s brand

Disadvantage:

  • Companies must adhere to the SEC (Securities Exchange Commission) strict rules, which can be a hassle.
  • More shareholders will emerge with voting rights reducing your control over the company.

Angel Investors

Angel investors are wealthy individuals or groups that are looking to invests in small startups or entrepreneurs. Angel investors look for investments that could potentially make them high returns.

The capital they provide can either be a one-time injection of cash or ongoing support to carry the company through difficult times.

Advantages and disadvantages of funding your business through the use of angel investors:

Advantages:

  • Angel investors are experienced investors and well connected, which means that they can help you get resources and customers.
  • Angel investors are comfortable with investing in new companies in comparison to venture capitalists.

Disadvantages:

  • Hard to find
  • High pressure as they are looking to make money and expecting a high return from your business

VC (Venture Capitalist)

A venture capitalist or VC is a professional investor that manages a venture fund. Venture funds are similar to mutual funds, except they invest in privately held startup companies rather than stocks.

Advantages and disadvantages of funding your business through the use of venture capitalist:

Advantages:

  • The venture capitalist has the ability to provide more capital in comparison to angel investors.
  • They become a real partner in business, connecting you with resources to help with your company’s operation.

Disadvantages:

  • Venture capitalist only looks to invest in companies that are established.
  • Extreme pressure as venture capitalist are highly focused on exit strategy and ROI
  • The venture capitalist has terms that are very burdensome to you as a business owner as they want to protect themselves.

Conclusion

If you are a business owner who is looking to raise capital, equity financing is a good option especially, if you are not looking to raise capital through the banks and avoid the hassle of loan repayments.

The 3 main sources of equity financing are through IPO, angel investors, and venture capitalists. Each source of equity financing has its own pros and cons that you need to take into consideration.

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