What You Should Know About Equity Financing

Equity financing is a popular method that businesses often use to raise funds, especially startups in need of cash or businesses looking to expand without having the capital. Before seeking equity financing, small business owners should be aware of some key points.

Understanding Equity Financing

Equity financing involves selling shares in a business to raise capital, unlike debt financing where a loan is secured from a financial institution. It is commonly used as seed money for startups or additional capital for established businesses wanting to grow. To obtain this type of financing, a business typically sells shares of common stock, where each share represents ownership of the company. As more shares are issued, ownership in the business becomes diluted.

Benefits for Investors

Shareholders benefit from equity financing through voting rights, dividends, and potentially selling shares for a profit. Due to the high risk involved, equity investors expect a significant return. Larger enterprises may offer various classes of equity shares with different prices and benefits to appeal to investors with varying financial objectives. Share issues are structured to ensure one owner or group retains control of the company.

Sources of Equity Financing

New business owners often invest their personal funds into their businesses for equity financing. External sources include angel investors, venture capitalists, and crowdfunding. Angel investors are usually family or friends who provide financial backing, while venture capitalists invest in well-managed businesses with competitive advantages. Crowdfunding involves groups of angel investors contributing small amounts online to support businesses.

Equity Financing for Small Business

Startup funding often comes from personal savings, and having a solid business plan is crucial for attracting investors. Making a personal investment can help attract other investors and lenders. Investors typically expect owners to contribute 25% to 50% of equity financing.

Disadvantages of Equity Financing