The Advantages and Disadvantages of Equity Financing

By Clay Wyatt

Equity financing involves exchanging ownership of your business for funding. In other words, you must sacrifice a percentage of your business (including profits) to a third party to raise funds in this manner. Typically, you can get this type of funding from angel investors, employees, family and friends, industry colleagues and venture capitalists.

This form of financing comes with numerous advantages and disadvantages. These are as follows.

Advantages

No Debt

For business owners who wish to avoid debt, equity financing does just that. By taking on investors instead of loans, you won’t have any debt obligations.

Outside Assistance

Anyone who invests in your business will want it to succeed. Thus, an angel investor, industry colleague or venture capitalist with related experience may offer valuable tips to help your business grow.

Improved Employee Performance

If employees invest in your business, they’ll have an extra incentive to perform well. This is why many businesses offer employee stock plans.

Disadvantages

Regulatory Burden

There are complex legal and regulatory issues involved in the process of equity financing. Complicated reporting is needed for investors at the end of each fiscal year, meaning that you’ll have to hire an accountant to deal with it!

Decreased Control

By enlisting investors, you’ll decrease the amount of control you have over your business. An investor will generally want some control over the outcome of his or her investment.

Note that a professional investor and even Uncle Joe may become very demanding. For example, if you want to close down for 2 weeks for a vacation, will an investor with 20 percent equity be comfortable with the foregone revenues?

Additionally, there are times when investors force out the original owner, which means you could have to send out resumes again if things start to go downhill!

Conclusion

Equity financing has numerous advantages. With it, you’ll avoid debt. Also, you’ll potentially gain expert advice from investors, which could increase the success of your business. Additionally, if employees invest in your company (now or in the future), they’ll have an extra incentive to perform well.

On the downside, Uncle Sam will put up some red tape via the mentioned regulatory burden. Also, most importantly, you’ll lose some control of your company. This is the largest risk you’ll face, as it could result in you being kicked out of the company you built!

Carefully consider the advantages and disadvantages of equity financing before deciding whether or not to use it. In a nutshell, if you can live with others having a say in your business and can deal with some extra regulations, then you can avoid debt and possibly get some expert advice.

Via: Business Finance Store  

(CFO On Call UA-38359200-1)