If you own a company and decide to get funds by selling your shares, that’s called equity financing. To put it differently, equity is the share of your company that you sell in return for cash. You can demand funds from investors to run and grow your business. Conversely, you also have to give them a partnership in your company through shares. To enumerate, you share the ownership of your company with people who buy the equity. We explain equity funding in this blog, hoping you learn about the equity option of obtaining funds for your company.
Difference Between Equity Funding And Debt Financing
People planning to start a business must first plan where they will get funding. You need money to run your business. You can get funding through debt funding and equity funding. It’s important to know what equity funding is and how it differs from debt funding. Let’s see the difference between the two.
- Firstly, debt funding is when you borrow and pay it back with interest. You may get funding from investors. In addition, you can get funds from financial institutions. On the other hand, equity funding is when you are selling company shares and not borrowing money.
- Secondly, a business owner has to repay the money borrowed from a lender. By contrast, there is no clause of repayment in equity financing. Admittedly, you don’t need to return the money you get when you sell shares to an individual or investor. So, there is no tension regarding paying back the money you earn in equity funding.
- Thirdly, lenders may charge you interest on the amount you have borrowed from them in debt financing. Sometimes, the claim is so high that repaying becomes problematic for you. On the other hand, you don’t need to pay interest on the funds you get if you sell equity or shares.
- It is relatively easy to get funds from debt financing. On the contrary, getting funds by selling shares is a slightly extended and complex procedure.
- The lenders approve your loan faster in debt financing if your credit history is good. Additionally, the lenders are ready to give the loan if you have collateral. Conversely, lenders may refuse a loan if you don’t have collateral. Comparatively, there is no need for a credit history in equity funding. Similarly, you don’t need to have collateral to get funds from equity. Business owners who don’t have assets as collateral should go for the equity funds option.
- You retain the ownership of your company in debt financing. Likewise, lenders don’t claim a right of ownership of your business. Furthermore, lenders don’t claim a right to vote in your enterprise. If you choose equity funding, you must give the shareholders a part of your ownership. People who buy your shares have a claim over your company’s rights. In like manner, your business’s request is based on the value of its shares. Negatively, you must give up a part of your rights in your company to shareholders.
- Another critical point is that debt funding gives you limited funds. At the same time, it’s a good option for you if you don’t need much money. However, you should choose equity funding if you need money. That said, selling shares of your company helps you get a significant amount of money.
- Not to mention, debt financing involves less risk than equity. You retain ownership of your company when you borrow funds from a lender. In addition, there is no need for you to ask. By contrast, equity is risky. You have to share the right of your company with others.
- Moreover, equity funding has more scope to provide you with significant funds. There are more chances of your business growth in equity than in debt financing. Admittedly, you get a small amount of money as funds from a lender. That may be sufficient for a business’s growth and expansion plans. However, you have immense growth capability if you sell your shares. It helps you get funds to expand your business.
Key Stakeholders Involved In Equity Funding
Anyone who wants to know about equity funding should learn about stakeholders. There are many stakeholders involved in equity financing. Let’s know about them in the section below.
1. Individual Investors
To begin with, let’s know about individual investors, including your family and friends. It can also include your colleagues and people you know. In the first place, they invest a limited amount of money in equity funding rather than a significant amount. Thus, there is a need for more people or individuals as buyers of your shares. People known to you may lack skills, knowledge, and experience. Therefore, they may need help to advise you or contribute significantly to your business.
2. Angel Investors
It’s essential to understand who angel investors are if you want to learn about what is equity funding. They are investors who are high profile and have high net worth. Indeed, the category of investors includes both individuals and groups of investors. They have an interest in buying your shares for an attractive return. Most importantly, business owners can get many funds from an angel investor.
Another critical point is that the investors have good industry experience and knowledge. They contribute to your business by giving you advice. Additionally, you get the benefit of connections from angel investors.
3. Venture Capitalists Or VCs
Next, let’s talk about venture capitalists. Notably, they are big investors who give you a lot of funds to help you grow your business fast. This category of investors includes individuals and firms who buy equity from you. Significantly, your company can increase and succeed if you sell shares to venture capitalists. Negatively, VCs claim a considerable share in the ownership of your company. You have to give them ownership rights in return for their funding and connections. Furthermore, Venture capitalists may get involved in your company’s internal decisions and functioning. That includes a role in the planning and operations of the business.
4. Initial Public Offerings Or IPO
Knowing about IPO is necessary if you want to get information about equity funding. You can choose this financing option if you have established your company well. Mainly, it involves offering shares for sale to the public. Business owners can get funds from IPOs if their company has grown significantly. Undeniably, shareholders have less control over your company than angel investors and VCs.
How Equity Funding Works
It’s essential to learn how exactly equity funding works. In the first place, equity financing is a process in which a company sells its equity. As an entrepreneur, you may start a business as a startup initially. Subsequently, the business grows and converts into an extensive and successful company. After that, you apply for funding. It would be best if you underwent multiple stages of obtaining equity funds:
- Startups offer equity instruments for sale to investors. Individuals and investors buy shares of your company from you.
- You can sell shares to retail investors and financial organizations if your business has established itself well.
- You can get additional funding later from secondary equity options.
We will give a brief introduction to the different types of equity instruments.
What Is An Equity Instrument?
Firstly, an equity instrument is a document that proves the ownership right of investors. Secondly, the document can be a share certificate that serves as legal evidence. Lastly, equity instruments can be in a natural or virtual form.
Types Of Equity Instruments
We have briefly explained some of the leading equity instruments below. Please read carefully if you’d like more information on equity funding and the types of equity instruments.
1. Common Stocks
They are shares sold by public companies to shareholders who provide funds to them. For that reason, you have to share the ownership of your company with the buyer of the stock. Furthermore, the shareholder gets voting rights in your business. They can also make important decisions like funding and business mergers. Another critical point is that this equity instrument has no provision for dividends. The common stocks are valued less than the preferred stocks. Additionally, they have a low priority.
2. Preferred Stock
This equity instrument has a higher dividend payment than the common stocks. Also, the shareholders have more rights over assets than holders of common stocks after a liquidation. However, they receive less money than people who have bonds if there is liquidation. The shareholders are not given any voting rights.
3. Convertible Notes
It is an equity instrument that combines debt investment with equity. Notably, equity starts as a debt investment but can transform into an equity investment. The principal amount a borrower takes from a lender and the interest can be changed into equity.
Equity Valuation And Determining The Share Of Ownership
People curious to know what equity funding is must also get information on equity valuation. The total amount of money that equity investors receive is called equity value. To put it differently, it’s the market cost of your shares. You can calculate this value easily. Just multiply the price of your claims by the number of issued shares. This is the method of finding the equity value of your claims.
Subsequently, a shareholder can determine the share of ownership in your business by doing calculations. To explain, divide the number of shares a shareholder has bought by the total shares issued. The value you get is the amount of shareholders’ ownership in a company.
Benefits Of Equity Funding
Let’s understand equity benefits now that you know what equity funding and instruments are. Firstly, companies can get access to capital through equity funding. Equity helps them overcome financial constraints. In addition, it gives them support for funding growth initiatives. Secondly, a business owner can scale their operation and expand the business in new markets with equity.
Furthermore, they can use the funds for research and development. Moreover, equity helps a company get strategic partnerships and increase its expertise. Selling your shares lets you connect with experienced investors who help you with their industry knowledge and networks. In addition, you get the benefit of mentorship and guidance. Mentorship enables you to deal with challenges.
Challenges Of Equity Funding
An essential aspect of learning more on what is equity funding is knowing about problems associated with equity. Aligning the interests of investors and entrepreneurs is a challenge in offering equity for sale. At the same time, investors may disagree with a business owner. The interests of investors may vary from the goals of a company. It is possible to mitigate financial risks through shared responsibility.
Furthermore, a company may face a problem with its brand credibility and visibility. As a result, they may need help attracting attention from customers. They may need more time to convince partners and potential investors. Moreover, there can be challenges in maintaining the company’s reputation and market positioning.
Conclusion
Now that we have discussed equity funding in detail, we hope you got an idea about what exactly equity is and how it works. To summarize, the blog explained how equity is different from debt funding. We learned about different types of equity investors and equity instruments. Indeed, shareholders can find out the value of their ownership in a company with some basic calculations. Lastly, we gave you a brief description of the benefits and challenges associated with equity. We encourage entrepreneurs to explore equity funding opportunities to unlock the growth and expansion of their companies.
