What is equity finance for businesses?

What is equity financing?

Equity financing is a way of raising finance by selling shares in your company to existing shareholders or new investors. The key benefit is that your business raises extra cash, but you don’t need to repay the funds – even if the business fails.

However, it also means giving away a percentage of your business and potentially some control over future decisions. Your business will also share a portion of its profits with investors.

What are the different types of equity financing?

There are several different types of equity financing, as outlined below:

Angel investors

Angel investors are high-net-worth individuals who are prepared to invest their own money into start-up or early-stage businesses in return for a minority stake. They typically have a wealth of knowledge, experience and contacts they can share with you to help your business succeed. They will usually look for companies that have good growth prospects and will give them a high return on their investment. 

It’s important to do your research when looking for an angel investor. It can be worth using social media to connect with potential investors. You should also attend local networking events. 

Venture capital

Venture capitalists tend to invest in start-up and early-stage businesses, too, but they don’t invest their own money. Instead, they channel finance from investment companies, such as pension funds. Because of this, they can invest a much larger sum than other investors. But this also means they will want a larger stake in return and might also want to have a say in your company’s strategy and management.

Venture capitalists typically seek to invest in companies poised for rapid growth with a proven track record of success.

Private equity

Private equity is best suited to established private businesses. Private equity firms raise capital from institutional investors, including pension funds and insurance firms, and use these funds with some of their own money to create a private equity fund. They invest this money in your business in return for a large stake in your company. 

Typically, private equity firms invest in a business and grow it for a number of years before selling their stake to another private equity firm or listing the company on the stock market.

Equity crowdfunding

Equity crowdfunding enables you to raise funds by listing your company on an online platform, such as Seedrs or Crowdcube. A large number of people (‘the crowd’) can then choose to invest in your business in exchange for shares. As well as helping you raise money, equity crowdfunding can also raise your business's profile, increasing its chances of success.

To get started, you need to determine how much money you need and create a campaign outlining what your business has to offer and what you plan to use the investment for. The crowdfunding platform will display your campaign for several days. Each platform will carry out its own checks to ensure your business complies with its requirements. 

Keep in mind that crowdfunding is generally better suited to businesses offering innovative ideas with good growth prospects. You should also be prepared to answer questions from potential investors.

Initial public offering (IPO)

An IPO refers to the first time you raise finance publicly and is often known as ‘listing’ or ‘floating’ on the public market – for example, the London Stock Exchange in the UK. 

If you do this, each investor will hold a minority stake in your business. You must regularly update your shareholders and the market with your financial information. This strategy is best suited to established, profitable companies that have already gone through several rounds of funding. 

Advantages and disadvantages of equity financing

Pros

• You don’t need to repay the funds

• You’re not adding any financial burden to the business because there are no monthly repayments 

• You might benefit from the knowledge and experience of your investors

• It can be a better option if you have poor credit

Cons

• You need to split your profits with investors

• You need to give a share of your company to investors

• You might have to give up some control over your company

• Raising the required funds can take a lot of time and effort

Is equity financing better than debt financing?

Debt financing is a way of raising funds by borrowing money from a lender, such as with a business loan. With debt financing, you need to pay back the borrowed amount plus interest. Taking on a lot of business debt comes with risk, and you must be sure you can meet the monthly repayments. Your business will also need a good credit rating to be accepted for the best deals.

On the other hand, if you choose equity financing, you are not obligated to pay back the amount invested in your business, so the financial burden is less. However, you need to be happy giving up a stake in your business in return.  

Both options have pros and cons. However, equity financing might be the better option if you have a limited credit history and don’t want the burden of regular loan repayments. It can also be more suitable if you would like to benefit from investors’ skills and experience and if you plan to grow quickly. 

Alternatively, if you’d rather maintain sole ownership of your business and you’re confident your business could generate a healthy profit, you might prefer to take out a loan.