Financing is the process of raising funds for your business. There are a number of reasons for raising funds, including, but not exclusive to, financing investments or paying the business’ liabilities. There are 2 forms of financing for a business:
- Equity Finance;
- Debt Finance.
Debt finance is the traditional borrowing of money to fund your business. It consists of an obligation on the business to repay the bond financier in the future.
Equity Finance is the process of raising capital (financial assets such as cash) by selling your business’ stock to investors. Commonly used to gain capital for your business’ investments or projects, equity financing is distinct from debt financing and has various advantages and disadvantages associated with it.
What is the Difference between Equity Finance and Debt Finance?
Ownership and Profits
The main difference between equity finance and debt finance is that in return for shareholders’ investment in your business, shareholders receive an ownership interest in your business. As a result, equity finance results in the shared ownership of the business proportional to their investment alongside the sharing of profits amongst shareholders. For example, if a business is publicly listed, then the number of shares owned determines the ownership interest of the business. As seen below, this can have various advantages and disadvantages.
Obligation of Payments
Secondly, financing through debt imposes an obligation on the business to pay the financier back, through interest payments or the value of the loan. Equity financing imposes no such obligation.
Advantages of Equity Financing
As is the nature of financing in general, equity financing raises funds for business’ to use for their general operations. Raising funds allows businesses to invest in projects or investments, or pay back loans and debt that can reduce their liabilities or increase their profits.
Freedom from Debt Obligations
As stated above, debt financing imposes an obligation on the business to repay the financiers whether through interest payments or the value of the loan. Equity financing imposes no such obligations and the business is thereby free from a possible debt as a result.
Equity financing brings aboard investors to the business. These investors can provide a useful network in the event that they wish to raise additional funds for future projects or investments.
The network of investors will bring to the business a variety of valuable experience, expertise and skills that can not only bring credibility to the business but also value. This network can be utilised to improve and develop the business further.
Disadvantages of Equity Finance
Shared Ownership and Profits
As a result of investor’s funds, they gain an ownership in the business. This can be disadvantageous if you wish to maintain control of your business. If you wish to maintain absolute control over your business, equity financing would not be suitable for you. It has its advantages, however shared ownership results in a trade-off between control and funding or expertise.
Time and Money
Raising equity financing requires time and money in approaching investors and ensuring the business is investment-worthy. This may take resources and management focus away from the core business activities that actively improves the profitability of the business.
Sources of Equity Finance
Family and Friends
Friends and family can be an important source of equity financing, particularly for new businesses. You can offer a partnership or share of your business to family of friends easily and without cost and time. However, there is a consideration of ensuring your relationship with them is not adversely affected by the shared business.
Investors such as business angels, invest their own funds into the business. They are individually invested in the company’s operations and profits as it benefits themselves. They further can provide expertise or advice on top of providing funds for the business.
Venture capitalists are large corporations that invest large amounts of money in start-up businesses with potential for high growth and large profits. Venture capitalists are a great way of obtaining a large amount of funds at once whilst providing management or industry experience and expertise. However, venture capitalists typically require a large controlling share or interest of the business.
Business’ can issue an Initial Public Offering (IPO) on the stock market to publicly offer shares to individuals and institutions to raise capital. The can be more expensive and complex and carries the risk of not raising funds if market conditions are poor.
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