Equity Financing for Businesses: How does it work?
What is Equity Financing?
It is when money is raised for company by selling stock to individuals or other investors. They receive a percentage of ownership in the company. It is commonly called equity finance, venture capital or private venture. It is done as an alternative to doing a bank loan for businesses. Banks are very strict and seldom loan money to new businesses.
How does Equity Financing work?
You must get an investor to make an investment in your company. The investor can be anyone you know personally, a foreign investor, another business, etc. You can be certain that they will get a percentage of ownership in your organization and serve as a member on the board of directors. They will also be a shareholder in your company.
If you decide to go with a venture capitalist, they will demand a high rate of return on their investment. Their equity funding in your business is not very secure like a bank loan. Many will only investment business with potential high growth in the future. Most venture capital investors will leave the company in about 3 to 7 years after the business is listed on the stock market. They will walk away once the stock sells, a management buyout or the business sells. At this time the venture capitalist will get their equity funding with capital gains. Most private investors will set goals for the company to meet over the next few years. They will have input in the company operations, risk and any future changes.
Is Equity Financing Right for You?
It is very common for new businesses to use venture capital, but many mature businesses will also take advantage of equity financing too. Many mature businesses are looking for additional financing for expansion purposes. Private investors want to see a good business plan. You would be surprised to know that many businesses that have been around for years do not have a business plan. Even if you were seeking a bank loan, they will require a business plan from you. A private investor want to see your business strategy, what kind of audience you will be targeting, know who your competitors are in the market, how much staff the business will require and how the company will be managed on a day to day basis. They want to know the risk management involved, future growth and projections. What are your business goals over the next five years? If you are selling products, investors want to know who will provide the supplies necessary to run your business.
New business will seek equity funding because it is virtually impossible for them to get a bank loan. With equity funds they will get support, guidance and a partnership that will help them achieve their business goals. Bank loan requirements are very restrict and in most cases they will not extend a loan to new businesses if they do not have enough equity. Equity Funds is a much easier avenue for new businesses in the industry.