More and more small business owners are turning to equity financing to meet their capital financing needs.
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As a way to inject cash into a growing business, equity financing certainly has its advantages. But it has several disadvantages as well. That's why it's important to know the facts about equity financing before you sign on the dotted line.
What is equity financing?
Equity financing is selling an ownership interest in your business in exchange for capital resources. If your business is experiencing a cash flow problem, then you should explore short-term financing with your lender because equity financing is probably not the best option. Likewise, because equity financing involves sharing ownership of the business entrepreneurs who view their business as a long-term investment tend to look for other financing alternatives.
What types of businesses can participate in equity financing?
Equity financing options are available for nearly every type of business from sole proprietorships to corporations. There are specific rules and guidelines governing equity financing in various business types, so you'll need to consult your attorney and/or financial consultant on the details for your business.
Where can I find investors for equity financing?
Investors come from a wide range of sources. Many small businesses find investors from their circle of friends, family members, and industry peers. However, equity financing is also available from so-called "angels" (investors with a personal interest in seeing small businesses succeed) and venture capitalists (investors who specialize in investing in businesses poised for rapid growth).
What are the benefits of equity financing?
Equity financing has a number of significant benefits over other forms of financing. First and foremost, it gives you the ability to save your cash resources for uses other than loan repayments. Another advantage is that (in most cases) the investor shares the burden of risk. If the business goes defunct, the investor is usually not entitled to recovery of their initial investment amount.
What are the costs?
Equity financing doesn't come without a price. As you might expect, there are financial and non-financial costs to selling an ownership interest in your company. On the financial side, equity financing means that you'll have to share your company's profits with your investors. The share percentage is typically higher than the interest you would pay to a typical lender.
On the non-financial side, equity financing also means that you'll have to share control of your business with your investment partners. Even if you still own a majority share in the business, you will have a legal responsibility to keep your partners in the loop about major decisions. This isn't always a bad thing, especially if your investors possess business or industry expertise. However, if you aren't prepared to give up at least some control then equity financing is probably not a good financing option.