Equity finance, the process of raising capital through the sale of shares in a business, can sometimes be more appropriate than other sources of finance, eg bank loans - but it can place different demands on you and your business.
Advantages of equity finance
Raising money for your business through equity finance can have many benefits, including:
- The funding is committed to your business and your intended projects. Investors only realise their investment if the business is doing well, eg through stock market flotation or a sale to new investors.
- You will not have to keep up with costs of servicing bank loans or debt finance, allowing you to use the capital for business activities.
- Outside investors expect the business to deliver value, helping you explore and execute growth ideas.
- Some business angels and venture capitalists can bring valuable skills, contacts and experience to your business. They can also assist with strategy and key decision making.
- Like you, investors have a vested interest in the business' success, ie its growth, profitability and increase in value.
- Investors are often prepared to provide follow-up funding as the business grows.
Disadvantages of equity finance
However, there are drawbacks of equity finance too. It's worth considering that:
- Raising equity finance is demanding, costly and time consuming, and may take management focus away from the core business activities.
- Potential investors will seek comprehensive background information on you and your business. They will look carefully at past results and forecasts and will probe the management team. However, many businesses find this process useful, regardless of whether or not any fundraising is successful.
- Depending on the investor, you will lose a certain amount of your power to make management decisions.
- You will have to invest management time to provide regular information for the investor to monitor.
- At first you will have a smaller share in the business - both as a percentage and in absolute monetary terms. However, your reduced share may become worth a lot more in absolute monetary terms if the investment leads to your business becoming more successful.
- There can be legal and regulatory issues to comply with when raising finance, eg when promoting investments.
For further information on the different ways to raise money for your business see business financing options: an overview.
FAQs
Less burden.
With equity financing, there is no loan to repay. The business doesn't have to make a monthly loan payment which can be particularly important if the business doesn't initially generate a profit. This in turn, gives you the freedom to channel more money into your growing business.
What are the advantages of equity finance? ›
Less burden.
With equity financing, there is no loan to repay. The business doesn't have to make a monthly loan payment which can be particularly important if the business doesn't initially generate a profit. This in turn, gives you the freedom to channel more money into your growing business.
What is the main disadvantage of equity financing? ›
Equity Financing also has some disadvantages as compared to other methods of raising capital, including: The company gives up a portion of ownership. Leaders may be forced to consult with investors when making a decision. Equity typically costs more than debt financing due to higher risk.
What are the pros and cons of equity investing? ›
The most important benefit of equity financing is that the money does not need to be repaid. However, the cost of equity is often higher than the cost of debt.
What are the disadvantages of the equity method? ›
One of the key disadvantages of the equity method is that it requires significant effort and resources. This is because the equity method requires a company to account for its investment in another company based on its share of the investee's net assets.
Which of the following are advantages of equity financing? ›
The main advantage of equity financing is that there is no obligation to repay the money acquired through it. Equity financing places no additional financial burden on the company, however, the downside can be quite large.
What are the advantages and disadvantages of equity shares? ›
Risk and return: Equity shares are considered riskier than certain fixed-income securities, such as bonds, because their value is subject to market fluctuations. However, they also offer the potential for higher returns, especially in the form of capital appreciation.
What is equity and its advantages? ›
Equity represents the residual ownership stake left for shareholders after a company's debts and liabilities are paid off. Understanding this key metric offers critical insight for stock investors when analyzing potential investments.
When to use equity financing? ›
During seed and angel rounds, equity is your best option because you won't have enough creditworthiness, cash flow or collateral to finance with debt. Angel investors won't care how many assets you have on your balance sheet. They want to see the potential of your business and the possibility of high ROIs.
What is downside risk of equity? ›
Downside risk refers to the probability that an asset or security will fall in price. It is the potential loss that can result from a fall in the price of an asset as a result of changing market conditions.
What Is Negative Equity? Negative equity occurs when the value of your home, car, business or other asset is less than what you owe on the loan. Let's say you put down $30,000 on a home valued at $300,000. You essentially own 10% of the car — your lender owns the other 90%.
What are the advantages of the equity method? ›
The advantages of employing the equity method
This is advantageous if businesses face obstacles or market recessions that affect their revenue. They can always modify their accounted profits by focusing on the performance of the companies that have invested in them rather than on their own.
What are the weaknesses of equity theory? ›
The limitations of equity theory include a lack of consideration for the role of equity in studies of adult learning and human resource development . Prevailing legal and economic debates on senior executive and worker pay also tend to dispute the relevance of equitable or distributive fairness concerns .
What are the advantages and disadvantages of equity securities? ›
The main advantages of equity securities are potential high returns, dividend income, and voting rights. Disadvantages include higher risk due to market volatility, no guaranteed returns, and dilution of ownership when new shares are issued.
What are the advantages and disadvantages of equity capital? ›
Knowing the share capital advantages and disadvantages can help you decide how much equity financing to use.
- Advantage: No Repayment Requirement. ...
- Advantage: Lower Risk. ...
- Advantage: Bringing in Equity Partners. ...
- Disadvantage: Ownership Dilution. ...
- Disadvantage: Higher Cost. ...
- Disadvantage: Time and Effort.
