What is Equity Financing?: Meaning, Pros & Cons, Examples

Raising capital becomes a necessity for many businesses as they grow. This can be done through equity or debt financing. Equity financing is one way that emerging businesses can raise capital, through the sale of shares. Learn more how equity financing works, and the pros and cons of this type of financing.

What is Equity Financing?

Equity financing comes into play when businesses, often start-ups, have a need for cash. It involves raising capital through the sale of shares to gain access to funds. Companies often need to engage in this process multiple times as they mature.  It is the process of raising capital through the sale of shares. By selling shares, the business gives up a percentage of ownership in the company in exchange for money. Funds can be used for short-term expenses like bills and overhead, or for long-term projects.

How Does Equity Financing Work?

Unlike a loan, equity financing doesn’t require businesses to repay any money borrowed. Instead, investors buy shares in the company for upfront capital. However, in exchange for the funds, the company gives up a percentage of ownership. This makes equity financing different from debt financing. Here are some examples:

Differences between Equity Financing vs. Debt Financing

Equity financing differs from debt financing: the first involves selling a portion of equity in a company, while the latter involves borrowing money that has to be repaid.  In case the company fails, the funds raised do not have to be given back to shareholders. For a deeper dive into the differences between equity and debt financing, read our Equity Financing vs. Debt Financing article.

Types of Equity Financing

There are generally two different ways companies can procure equity financing: through stocks with investors, or a public stock offering. Here are a few examples:

Angel Investors

Venture Capital Firms

Crowdfunding

Private Equity Firms

Initial Public Offerings (IPO)

Pros and Cons of Equity Financing

As with every financing option, there are pros and cons to equity financing. Let’s look at the most significant ones:

Pros

No repayment obligation: Unlike debt financing, there is no money that needs to be repaid, relieving companies from the burden of repayment.

Access to large amounts of capital: You’ll have more cash on hand than you would with other types of financing.

Potential for valuable guidance and expertise from investors: Depending on the source of the company’s equity financing, you may gain access to important business contacts and expertise from investors.

Cons

Giving up ownership and control of the company: One major drawback is that in exchange for the funds, you’re giving away partial ownership and control of your company. This means you’re bringing in other stakeholders and you’ll need to consult with your investors during the decision-making process.

Potential for conflicts with investors: By giving up a part of your company in exchange for capital, decision-making and working together also becomes more difficult. Differences in management style and vision can lead to tension and potential conflicts.

Losing some of the profits: 100% ownership means you’re keeping 100% of the profits. Once you give up a percentage of ownership, let’s say 25%, you are also only entitled to the profits of the 75% that you still own. This could potentially cost you more in the long run than what you’d pay for a loan.

For more differences between working with an investor vs. getting a loan, read our guide.

Examples of Equity Financing

Equity financing is a common source of capital for fast-growing start-ups and companies. As an example, Uber has raised a total of $25.2B in funding over 32 rounds according to Crunchbase. Companies like Uber, Facebook, AirBnb and others rely on equity financing to grow.

5 Reasons to Use Equity Financing as an Option

Here are the most common reasons that companies use equity financing:

1. Need for significant funding: When the need to raise capital arises, equity financing can make a big difference in the growth of a company. Significant amounts of capital can be secured through the sale of shares.

2. Lack of collateral or credit history: Businesses that do not have collateral to lend against, such as inventory, equipment or accounts receivable, cannot take advantage of some forms of debt financing, and may find equity financing to be the best option.

3. Desire to bring in experienced investors: If bringing in new stakeholders and making decisions together sounds exciting, then equity financing may be a good option for your business. Oftentimes business can profit from the expertise and contacts that come with an experienced investor.

4. Long-term growth plans: Unlike debt financing, equity financing is a long-term investment and partnership with investors. It can also raise the substantial capital you may need to promote rapid and greater growth that can make your company attractive to buyers and a sale possible later on.

5. Flexibility in use of funds: Debt financing sometimes limits the use of funds and places restrictions on a business. Equity financing allows for more flexibility when using the funds, whether it is for short-term expenses or long-term projects.

How to Start with Equity Financing

A good first step is to conduct research and find potential investors that align with your company’s vision. Once the research is done, preparing a strong business plan and pitch would be the next step. Brands should also meet with their accountant or attorney to get their advice on the next steps.

After reviewing through the points above, you should have a better understanding of the pros and cons of equity financing. Partnering with an investor involves giving up partial ownership which gives them a voice in your business. Loans are a more short-lived partnership that ends when you repay the borrowed money. The best choice may come down to a few factors unique to your particular situation.

How Assembled Brands Can Help

With an overwhelming amount of financing options available, you might wonder which option is the right fit for your business. The best choice may come down to a few factors unique to your particular situation. After reviewing your books and choosing the lenders that stand out to you, it is worth discussing your options to get a better understanding of what is being offered and what makes the most sense for your business.

The team at Assembled Brands is always happy to assist you in evaluating your options, even if your best one is not an asset-based loan. We offer financing solutions such as inventory financing and ecommerce funding that do not dilute equity and keep you in full control of your business.

Discover how your brand can benefit from Assembled Brand’s simple and streamlined process. Apply today!