Starting or expanding a business takes money (or capital), and lots of it. If dipping into personal funds is not viable, most business owners or entrepreneurs are left with two capital raise options: debt or equity financing. While the former involves taking out a bank loan or credit card, the latter raises capital by selling company stocks.

Whether you’re an established business or are just starting up, the capital raising process can be long and complicated. Before you dive in headfirst, you need to be prepared and understand your options. 

In this article, we’ll explore several equity raising methods and walk you through the pros and cons of equity financing.

What is equity financing?

Equity financing, also known as equity funding, is when a business raises funds by selling company stocks. These can take the form of common shares or preferred shares. In doing so, you’re essentially selling off little pieces of your company to investors to raise capital.

Equity financing is often used by startups to kickstart their business, or by small businesses looking to expand. Several forms of equity financing exist; let’s look at them now. 

Types of equity financing

Common types of equity financing are:

• Angel investment
• Equity crowdfunding
• Venture capital
• IPO

Angel investments

An angel investor (also known as a private investor), is a wealthy individual who provides capital for a business. In exchange, they receive ownership equity (a part of your business).

Angel investors can be friends, family, entrepreneurs or retired business owners themselves. As financiers, they’ll usually invest when a business is in its early stages and they are confident they’ll get a return on their investment.

Equity crowdfunding 

A common way to raise money for your business is through equity crowdfunding. This can take place on crowdfunding platforms like Kickstarter, AngelList or IndieGoGo. 

Equity crowdfunding is similar to crowdfunding (where money is raised by a number of individuals to fund a project or business). However, equity crowdfunding donors become investors by getting a small share in your business in return for their investment. 

Venture capital firms

Venture capitalists are like angel investors, but multiplied tenfold. Instead of a single investor, you’re raising capital through a firm. These firms look at businesses that either have demonstrably high growth or the potential for it.

Unlike angel investors, venture capitalists tend to invest in more mature, established businesses and will also take a more active role in your business. Although they invest less frequently compared to angel investors, they also invest more capital. When they invest in your company, they want to see that you’re ready and prepared to use this capital to scale the business.

Initial public offering (IPO)

An Initial Public Offering (IPO) is when a company offers its shares to the public for the first time. This type of equity raise is used to generate additional capital for a startup company, and in exchange, shareholders get an early slice of your company. After IPO, the company’s shares are traded in an open market.

Which is better, equity or debt financing?

To equity raise or to debt raise, that is the question. Each has pros and cons. So when it comes to choosing the best one for you, it’s critical you take into consideration the current stage of your business and what your future business plan looks like. 

To help guide your decision, here are some benefits and drawbacks of equity financing. 

Advantages of equity financing

• No repayments: Because equity is something you sell, not borrow against; you won’t have to make repayments. The main advantage of equity financing over debt financing is that you have no debts to pay off.
• No credit, no problem: Unlike debt financing, when lenders can be very concerned about your creditworthiness, a lack of credit history is often not an obstacle to raising funds through equity.
• Mentorship: When you secure an angel or venture capital firm, you gain access to a wealth of knowledge and experience.

Disadvantages of equity financing

• Loss of control: When you sell company shares, you are potentially at risk of losing ownership of your own business. Each time you bring on a new equity investor, your personal ownership of the business becomes diluted. Think of it like sharing a pie. The more slices you give to others, the less you have for yourself. With debt financing, on the other hand, the pie is all yours.
• Sharing profit: As you share ownership with your equity investors, you also share your profits. Although you don’t have to pay any debts with equity financing, you will have to pay your investors via profits.
• You might be too small: Your business might be too small for an angel investor or venture capitalist to take interest in it. Roughly only 80% of small businesses survive the first year, and that number drops to 50% once it hits the five year mark. Equity investors need to be confident they’re going to get their money’s worth.

Pros and cons of debt financing

Compared with equity financing, the most significant disadvantage of debt financing is - as it says on the label - the debt that you will need to repay. On the other hand though, if you don’t want to cede any ownership of your company to investors, debt financing may be a better choice.

Learn more: Debt Financing

Raise capital smarter, not harder

Equity financing can be a smart move for many startups and small businesses, but is it the right capital raising method for you? Find out more about how to raise capital by browsing our website.

Whichever route you choose, you’ll need to ensure you have all your material information in order. From IP and marketing strategies to business financials and legal information, potential investors will want to see it all.