So, you’ve decided you want to be an entrepreneur: you wrote your business plan, did the market research, maybe even have a prototype, or even some customers. Your young business may even be growing. However, you realize your business is growing slowly and you want to do something about it. Obviously, if you had more money you could invest in marketing, in hiring more staff or even in buying out your competitor from down the street. But what kind of financing is good for you?
When you need a cash injection to grow your business, your two main options are equity financing and debt financing (naturally, there are some hybrid solutions, but these are usually suitable for companies that are several years down the road). In this two-part series, I’ll cover the pros and cons of each. Stay tuned for next week’s discussion on debt financing.
Equity financing
In this method, you essentially give away part of the ownership of your business to the investor, usually by issuing shares of the company, in return for cash. Depending on the investment agreement, this might also involve granting some other rights to the investor, such as the right to receive some of the company’s dividends, or the right to vote on some important decisions regarding the company and the way it is doing business.
The main pros of equity financing are:
- Equity financing doesn’t require interest or principal payments, so the financial burden on the company is lower. Therefore, equity financing is perfect for companies in the pre-revenues stages. Also, this financing is the best alternative companies that have no assets to pledge as a collateral, such as technology companies that mainly have IP assets.
- Equity financing is a great way to bring on board someone whose help you either want or need.
- Equity investment usually shows a strong sign of trust from your investor’s side and this trust also signifies the investor will support the company over a longer period of time.
- Finally, since such an investor already has some stake in the company, the chances are high that when the company will need an additional investment, he will reach into his pocket in order to protect that investment.
The cons of equity financing are:
- You are not the sole owner of the company anymore. As a result, some decisions are not yours to make. If you’re the person who started a business because you didn’t like being told what to do, this is an important consideration.
- It is usually harder to raise equity, because the investor is not protected (by, say, some collateral) in case the business fails. Thus, if you require a swift injection of capital, equity financing may not be for you.
One should understand the advantages and disadvantages, as well as the specific terms of equity financing before deciding to go forward. Such research can make all the difference between a successful and failing company.
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