What is Equity Business Financing?

Equity business financing is the selling of shares of a company to fund capital, and the investors who buy the shares also purchase ownership rights for the company. Equity business financing could refer to the selling of all equity instruments like preferred shares, common stock, and share warrants.

Equity financing is crucial when a company is in its initial stage to fund plant assets and the initial operating costs. Investors earn profits from dividends and when shares rise in value.

Significant Sources of Equity Business Financing

When a business is privately owned, equity business financing may be obtained from crowdfunding platforms, angel investors, venture capital firms, or even corporate investors. In the end, shares could be sold to the general public through an IPO.

1.   Angel investors

The angel investors include wealthy people who buy stakes in businesses that they believe can earn more income in the future. The investors typically bring their knowledge of business knowledge experience and their connections, which can benefit the business in the long term.

2.   Platforms for crowdfunding

Crowdfunding platforms enable the members of the general public to invest in the business in tiny amounts. People who are part of the public choose to invest in companies because they believe in their concepts and want to earn back their investment through future dividends. The contributions of the public are combined to achieve the desired total.

3.   Venture capital firms

Venture capital firms are a set that invests in companies they believe will increase and may be listed on exchanges shortly. They invest more significant amounts of money in companies and get a more considerable percentage of the company's assets when compared to the angel investor. This method is often called the financing of private equity.

4.   Corporate investors

Corporate investors are large corporations who invest in private businesses to help them obtain the necessary funds. The funds are usually sourced to create a strategic alliance between two companies.

5.   Initial public offerings (IPOs)

Established businesses can raise funds through the initial public offer (IPO). The IPO lets companies raise money by offering shares to the public to be used for trading on the capital markets.

v  Advantages of Equity Business Financing

1.   Alternative funding source

The primary benefit of equity funding is that it provides businesses a different source of financing alternative to debt. Startups that aren't eligible for loans from banks with large amounts can obtain funds through entrepreneurs, angel investors, and crowdfunding sites to pay their expenses. In this scenario, equity business financing is considered more secure than debt financing since it is not required to repay its shareholders.

Investors usually concentrate on the long-term and do not expect a quick yield on investment. It allows the business to invest the profits generated by its operations to expand the business, rather than focus on debt repayment and interest.

2.   Business contacts, management skills, and additional sources for capital

Equity business financing also offers specific benefits to management. Confident investors want to participate in the company's activities and feel driven by their desire to contribute to the growth of a business.

Their experience and success allow them to offer invaluable assistance about contacts in the business world, managerial expertise, and access to other resources for capital. Many angel investors or venture capitalists can assist businesses in this way, and it is vital during the beginning stages of a new company.

v Disadvantages of Equity Business Financing

1.   Diluted ownership and operational control

The major drawback to equity business finance is that the company owners have to give up part of their ownership and reduce their influence. If the company is successful and profitable shortly, a specific percentage of the company's profits should be paid out to investors in the shape of dividends.

Many venture capitalists require an equity share of between 30% and 50 percent, particularly for new companies with no financial history. Many founders and business owners do not want to reduce this amount of the company's power, limiting their options for equity financing.

2.   Tax shields are not provided.

In comparison to debts, equity securities have no tax-free protection. Shareholders' dividends are not tax-deductible expenses, while interest payments can be eligible to receive tax advantages. They add to the cost of equity business finance.

In the long run, equity business financing is thought to be a more costly method than debt, and this is because investors demand an increase in returns than lending institutions. Investors are at risk when they fund a business, so they expect a higher percentage of returns.