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The pros and cons of equity financing

There are quite a few different ways to raise funds for your startup or existing small business. The traditional path is known as debt financing, which involves taking on a bank loan or private loan. A different approach to gain capitol is to seek equity financing by issuing stock in your business. This option allows you to sell shares of your company to investors, which then injects your business with cash and leaves the investor with the chance to make a high return. But it is important to understand that there are pros and cons to equity financing. Knowing all the ramifications of this type of financing can help you determine if equity financing is the right move for you and your company.

  • Pros of Equity Financing-The use of equity financing will allow you to cut out the bank as a business partner. In addition instead of spending cash on loan repayments, you can use the infusion from equity investors to grow your business. Furthermore, equity investors can also help reduce your personal risk in the business. Also it is important to realize that in the event your business fails, you would still be required to pay back any bank loans you take, or reorganize the debt payment under bankruptcy protection. A crucial difference is that equity investors, however, usually do not have the same rights as debtors and you would not be required to return their original investment in the event your business collapses. Equity investment should be viewed as a long-term solution and a means that help you to inject both cash and experience into your start-up.
  • Cons of Equity Financing-You should keep in mind that if you are seeking cash for the short term, offering equity is not the right approach. Investors will want their capital to help the company make good investments and position itself for medium- and long-term growth. If your cash flow has not picked up as you expected, you may want to consider calling a bank instead. Furthermore, you should understand that you have to cede some control over your company's operations if you offer stock to investors.

When consider using equity financing it is important to consider what your long-term strategy is for your business. Investors will be looking for a plan to get a return on their investment, and that plan could include merging with another company, selling the company to a larger firm, or conducting a public stock offering which would then allow investors to sell their stock on the open market. Business owners should understand that along with sharing control, you will also be sharing the profits. It is important to make sure to run the calculations on any potential equity agreement. You can find that you are paying a larger percentage of your profits to investors than you would toward a bank loan.

There are numerous sources of equity financing. Some of these are:

  • Venture capitalists. Venture capital funds are professional investment organizations that invest in growing industries only to make a profit. VC firms know several of their investment choices may not pan out but are often willing to take that risk in return for an occasional windfall. You should keep in mind that securing a venture capital firm that specializes in your industry means you will be bringing in owners who can offer experienced opinions on running the company but may also seek to exert significant control.

  • Angel investors. These are individuals who will have a personal stake in seeing a business proposition succeed. Angel investors often tend to focus their investments on sectors in which they have a personal interest.

  • Initial public offerings. Depending on the stage of development of the company, it may be possible to raise funds by offering shares in the company to the public. You should keep in mind that this activity is highly regulated and expert advice should be sought prior to embarking on this route.

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