Financing 101 (Part 2): Taking a Closer Look at Equity Financing
Finding capital for your company is key to its continued success and to its growth. Financing allows your business to take the next step or move to the next level. While borrowing money or taking on debt is one way to get the capital your company needs, it’s not the only option. Businesses also often choose to receive equity financing, either along with or instead of taking on debt. We discussed the benefits and risks of debt in a recent post. Today, we’ll take a closer look at the advantages and drawbacks of equity financing.
The Source of Equity Financing
One of the major differences between debt and equity financing is the source of the money. Debt financing comes from a lender, such as a bank. Equity financing comes from an investor in the company. The relationship between a business and an investor is considerably different from the relationship between a bank or lender and a business.
Since an investor is taking part ownership of the company, he or she will generally be more involved in working with you and in overseeing certain aspects of the business. The investor now has a stake in your business, which usually means that he or she will be more inclined to see it succeed.
Benefits of Equity Financing
The relationship that develops between you and the investor can be seen as an advantage of receiving equity funding. Often, an investor has ample experience, not only investing in business, but also in understanding the ins and outs of the market. Some investors are more hands on than others and may offer your company guidance as it grows. Whether an investor is very involved in your business or not, most understand what a company needs to grow and the time it takes to develop a business or to take the next step.
Equity financing can also help boost your company’s reputation. If one investor decides that your service or product is worthwhile or that it has the potential to be profitable, other investors might also take interest in what your business has to offer. Interest from multiple investors not only means the potential for additional financing. It also means the potential to build and develop strong relationships in the business world.
Risks for Business Owners
While there are certain rewards when it comes to working with investors, there are also some risks. Finding the right investor can take some time. It’s more about building a relationship with the source of the financing than it is about successfully completing an application. There’s a risk that an investor and a business won’t be a good match, which can create conflict down the road.
While you don’t have to make monthly payments to your investor the same way that you make to a lender, there is an expectation that your company will produce a return on the investment. Not establishing an expectation for that return with the investor before entering into a financing agreement can create issues if your business is successful or if it encounters difficulties. Making sure that you and the investor are on the same page in terms of expectations is one way to reduce the potential for conflict.
If a business and investor can’t come to an agreement, there is a way to end the relationship. That involves one or the other buying the other out. Buying out an investor can be expensive for you, as you’ll usually need to pay more than he or she originally invested in your company to get that share of the business back.
Deciding between debt and equity financing isn’t necessarily an either/or choice. Your company might benefit from some debt and some equity or more equity than debt. The decision might also depend on how established your business is or where it is in terms of growth.
Working with a virtual CFO and the team at New Direction Capital means that your business will be able to make the right choices for it when it comes to finding capital and when it comes to building relationships with investors. If it is time to take the next step and you are looking for ways to grow, contact us for more information today.