What is Equity Financing and How to Get Equity Financing in 2024

What is Equity Financing and How to Get Equity Financing in 2024

Say goodbye to waiting for approval for business loans and grow your business through equity financing. Equity finance is a business funding option that’s perfect for both short-term and long-term needs. It has no restrictions on the firms that can use it either.

Equity financing is the sale of company shares in exchange for money. This funding comes in many forms, including venture capitalists, angel investors, individual investors, crowdfunding, and initial public offerings.

Equity finance offers loan-free business funds, free business experience, and low risk. The downsides are that it takes time and money and may result in a change in control of the company.

That isn’t all there is to know about equity funding, though. Learn how it works, how to get it, and reasons to consider equity finance.

What is equity financing?

Equity financing is a form of sourcing business funds where the company’s owners issue shares in exchange for financial backing. Selling a company’s shares is the same as selling part of the company’s ownership. So, some business owners resort to this form of funding only when they have exhausted all other possibilities.

Equity financing isn’t restricted to any type of business; it’s used by both public and private companies. This method doesn’t have to be used once, either. Apart from allowing a business to gather capital, it can still use this method several times during its lifetime.

In order to attract investors who will provide equity investments, the business must be promising. Unless they are assured of a Return On Investment (ROI) of at least 30%, most investors will not even consider supplying capital. Those looking to use this kind of capital must be prepared to pitch their idea to potential backers.

How does equity financing work?

Business equity financing for a company requires an agreement between investors and the company’s owners. The business owners will give up a certain number of shares of the company in exchange for cash from the investors.

These stocks may take many different forms, including:

  • Common stock
  • Equity instruments: Titled common stock, preferred stock, options, and limited liability company membership interest
  • Quasi-equity instruments: Loan stock, debentures, bonds, revenue-sharing agreements, and mezzanine financing
  • Equity units: Warrants and common shares

When sourcing for this form of financing, keep in mind that getting a larger investment means you’re giving up more shares. If you give up more than 50% of the total shares in the company, the company’s leadership has effectively changed hands.

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Types of equity financing

In the business world, there are numerous forms of business equity financing available, and they include:

Angel Investors

These are the first types of investors that most start-ups meet. Angel investors are people or groups that believe in providing financial help to businesses that they believe will provide decent returns.

When these individuals provide their aid, they also offer industry experience and make available their connections and insights.

Individual Investors

You never know who from your circle of friends, colleagues, relatives, and friends might be interested in investing in your company.

Individual investors typically have much less capital to invest in a business than angel investors. Therefore, if a business owner wishes to use them as a source of capital, they must first amass a sizable amount of them.

When compared to angel investors, individual investors provide significantly less in the way of expertise, knowledge, and contacts. However, their funding is much easier to receive.

Crowdfunding

Entrepreneurs can raise money using online crowdfunding platforms like Indiegogo, GoFundMe, Patreon, Crowdrise, WeFunder, and Kickstarter.

Through crowdfunding, a sizable number of people who are all devoted to the success of the same company come together. Unlike other cases of crowdfunding, this form is called “Equity Crowdfunding,” where the business shares its revenue with the participants.

This is similar to individual investors in the sense that the individuals gathered can only invest a small amount. Since there are a lot of them, however, a substantial amount will be gathered in the end.

Initial Public Offerings (IPO)

This is a form of equity financing that is available during the later stages of a business. This is where an existing company will publicize the release of stock to the general public. However, this requires a lot of money, time, and effort to implement, so it is typically only used by well-established companies.

Compared to angel investors and venture capitalists, an IPO doesn’t relinquish much control over a business. So, investors that offer their aid don’t usually expect a large amount of company stock.

Venture Capitalists

This is a case where a large company or firm makes substantial investments in a business that deserves them. Such businesses usually have predictable high-growth potential, solid prospects for success, and many other advantages.

Compared to other sources of equity finance, venture capitalists usually demand a large share of company stocks. They might even demand to be deeply involved in the daily operations of the business to better oversee their investments. In turn, they’ll provide their connections, resources, experiences, and financial investment.

Most venture capitalists are known to enter during the early stages of a business. They then sell their stocks during the IPO stage to reap maximum benefits.

How to get equity financing

There is no structured method for how to get equity financing for a business. Nonetheless, you can follow the general guide below to finance your business.

  • Angel Investors: The first thing to do here is to get in contact with an angel investor. This can be done through pitch competitions like Startup Canada or informally by advertising on social media sites like LinkedIn. After which, you’ll have to convince the angel investor to invest in your business idea.
  • Individual Investors: This is an informal process that just involves convincing friends and family to invest in your business.
  • Crowdfunding: To get equity funds through crowdfunding, you’ll have to choose a crowdfunding platform. The next step will be to sign up and follow the steps on the site to list your business. After which, you can share your business details to allow others to fund it.
  • Initial Public Offerings (IPO): IPOs can be a long and tedious process, and there’s a need for adequate preparations for them to be successful. The preparations include reviewing the business plan, appointing a board of management, hiring lawyers and public relations experts, etc. After this, you’ll have to list your business and also comply with the rules governing public companies.
  • Venture Capitalists: It’s difficult to get in touch with venture capitalists without the appropriate connections. So, you’ll need a lawyer, a strong business associate, or another investor to connect you. The next step is to convince venture investors to back your business by presenting a well-reasoned pitch.
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Pros of equity financing

The benefits of using business equity financing include:

You Don’t Pay It Back

Compared to loans and other forms of business funding, equity finance isn’t paid back. Rather, investors seek a return on the investment that they’ve made in the business. The investors are also willing to offer their efforts to help the business venture succeed.

Investors Offer Valuable Experience

Most investors that offer equity funding are experts or experienced individuals in that field of business. If they’re not experts, they’ve probably got connections with experts. They also offer valuable advice and insights, which would be useful to many businesses, especially start-ups.

It Offers Low-Risk Business Funding

Unlike business loans that you have to pay back regardless of whether the business succeeds, equity finance offers less risk. That’s because investors are offering their funds and trusting the business’s capability to grow. Hence, they take on the risk of receiving benefits as the business grows or losing their investments if it falls.

Cons of equity financing

The drawbacks involved in business equity financing include:

Business Ownership Is Given Away

When equity finance comes into a business, some business stock is given away in exchange. This business stock also corresponds to the ownership of the business.

As such, engaging in equity funding means that the ownership of the business is now shared with the investors. So, when decisions are taken, the investors would have to be made aware, and they can also stand against some business decisions.

Business Profits Are Given Away

Everyone who offers equity funding to a company gets the right to receive profits equal to their shares. This means that the profits of that company do not solely belong to its owners. A part of it would always go to the investors with shares in that company.

The Process Can Be Time-Consuming

To receive equity finance, entrepreneurs would have to pitch their ideas to investors and potential shareholders. They’ll have to display the potential of their company and show its profitability.

This process takes a lot of time, especially when you consider the fact that you’ll have numerous meetings with the investors. Even when the shares are given out, every major step in the business would also require another meeting to update the shareholders.

Reasons to consider equity financing

Are you confused about whether you should source business funds through equity finance? Well, there are numerous reasons why most business owners favour equity finance, and some of them are:

Building Valuable Business Connections

Equity funding offers entrepreneurs the opportunity to connect with business experts. These business experts can offer vital information that will help that business to grow. Since most investors are not financing their first businesses, they’ll be able to offer a wealth of experience to entrepreneurs.

A Valuable Alternative When in Debt

If you’re already in debt, then equity funding is a business financing solution that won’t worsen your situation.

With equity funds, you don’t have to worry about taking a new loan or having your credit score hurt your chances. The only thing that you need to do is relinquish some shares of your business, and you’ll receive business funds.

To Fund Startups

Angel investors are one of the best sources of capital for startups, and they’re a form of equity fund. Unlike loan organizations, which are more likely to fund existing businesses, many equity fund providers prefer startups.

As these investors fund the startups, they also provide valuable experience that they can use to survive in their early years.

To Fund Risky Business Ideas

Although business loans are a suitable source of business funds, they’re not the best for funding risky ventures. Banks and loan organizations offer their funds to businesses that are likely to repay them.

However, if the business is a risky one with a high chance of going bankrupt, they’ll disapprove of that loan application. However, many investors would be ready to incur the risk associated with equity funding in exchange for attractive profits.

Equity financing: what it is and how to get it conclusion

Equity financing has long been a popular choice for businesses, whether they are just getting started or want to grow. It’s risk-free, doesn’t put a company into debt, and even brings free business connections and experience. Of course, there are dangers to selling off business ownership, but the risks are worth it.

Among the various business equity financing options, venture capitalists and IPOs are more suited to large companies. That’s because the liquidity of their shares is high, so it’s more attractive to investors.

Nonetheless, small and medium businesses can make do with equity financing options like angel investors, crowdfunding, and individual investors.

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FAQs about equity financing

Are equity and debt financing the same?

No, debt and equity financing are not the same. Where equity funding involves the sale of company shares, debt financing involves borrowing money to finance the business. Debt finance users must, therefore, repay their loans with interest. However, debt financing has the advantage that the business owners retain full control of the company.

Is debt financing cheaper than equity finance?

Yes, debt financing is cheaper than equity financing, as loan interest rates are lower than investor dividends in the long run. Unlike loan interests that cease when the loan is paid off, dividends are paid as long as the investor possesses business shares. Loan interest is also tax deductible, while investor dividends are not.

What factors should a business consider when they want to give out business equity?

The first thing every business owner should consider is whether the potential returns of such an investment are worth it. Business owners would also have to consider if the equity they’re giving out would dilute the available shares too much. When shares are diluted too much, it can lead to volatility in the value of the stock.

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July 17, 2023
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