Advantages and disadvantages of equity finance
Equity finance, the process of raising capital through the sale of shares in a business, can sometimes be more appropriate than other sources of finance, eg bank loans - but it can place different demands on you and your business.
Advantages of equity finance
Raising money for your business through equity finance can have many benefits, including:
- The funding is committed to your business and your intended projects. Investors only realise their investment if the business is doing well, eg through stock market flotation or a sale to new investors.
- You will not have to keep up with costs of servicing bank loans or debt finance, allowing you to use the capital for business activities.
- Outside investors expect the business to deliver value, helping you explore and execute growth ideas.
- Some business angels and venture capitalists can bring valuable skills, contacts and experience to your business. They can also assist with strategy and key decision making.
- Like you, investors have a vested interest in the business' success, ie its growth, profitability and increase in value.
- Investors are often prepared to provide follow-up funding as the business grows.
Disadvantages of equity finance
However, there are drawbacks of equity finance too. It's worth considering that:
- Raising equity finance is demanding, costly and time consuming, and may take management focus away from the core business activities.
- Potential investors will seek comprehensive background information on you and your business. They will look carefully at past results and forecasts and will probe the management team. However, many businesses find this process useful, regardless of whether or not any fundraising is successful.
- Depending on the investor, you will lose a certain amount of your power to make management decisions.
- You will have to invest management time to provide regular information for the investor to monitor.
- At first you will have a smaller share in the business - both as a percentage and in absolute monetary terms. However, your reduced share may become worth a lot more in absolute monetary terms if the investment leads to your business becoming more successful.
- There can be legal and regulatory issues to comply with when raising finance, eg when promoting investments.
For further information on the different ways to raise money for your business see business financing options: an overview.