The main advantage of equity financing is that a company can quickly raise capital to grow the business. The disadvantage is that the capital comes at the expense of shares in the company. This means whoever invests funds into the firm will own a part of it through the shares.
But while losing some ownership of the business may sound detrimental, it can actually be the most beneficial path to take for many companies. Without the cash provided by selling the shares, it may not be possible to grow the company at all. So while the original business owner’s slice of the pie is technically smaller after equity financing, the pie itself should be significantly larger.
The big decision when sourcing funds is choosing debt versus equity financing. But whereas debt involves borrowing money to be repaid with interest, equity financing does not have any repayment obligations. The only advantage debt has in the debt versus equity financing debate is the retention of full ownership.
Sources of equity financing
There are different kinds of investors that provide equity financing, and each has their own advantages and disadvantages. We generally understand where loans come from, but let’s look closer at the sources of both public and private equity financing.
Initial public offering (IPO)
An initial public offering (IPO) is when a company raises funds by offering its shares to the public via the capital markets for the very first time. This option tends to favour more established firms, as the brand recognition creates immediate interest in the shares. Many very large companies have used IPOs to generate cash, including Google and Facebook.
Crowdfunding platforms are another way for the public to invest in companies by buying shares, although this method differs significantly from an IPO. The company selling shares remains private, but the crowdfunding investors can buy small amounts of shares with the hope they will get a good return after the company’s future success. This method usually requires a relatively high number of crowdfunders to raise the requisite capital.
Venture capital firms consist of dedicated investors who invest in firms they think will grow quickly and eventually be listed on a stock exchange, where big money can be made on their initial investments. Venture capitalists tend to invest larger amounts than crowdfunders and others, but they will also expect a bigger return.
Large companies can also invest in smaller companies – these are known as corporate investors. They provide smaller businesses with the funds they need to grow, although the return expectations can differ greatly. For example, one large company might invest in a smaller company in order to develop a strategic partnership between the two firms, rather than to simply make a profit by selling the shares in the future.
An angel investor is a wealthy individual who will buy company shares in the belief that the business will grow and be successful. They do generally expect a higher return on their investment, although their exact motivations can differ. There are some altruistic examples of angel financing, although the majority will indeed intend to make a profit. One significant benefit of angel investors is that they are more likely to lend their expertise, experience or connections to help the business succeed.
We can help
The initial organisation of equity financing can be time-consuming with all the research and preparation required. If you would like to learn more about the advantages and downsides of equity financing, get in touch with the financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments to help you arrange equity financing and grow your business.