An alternative to borrowing money to fund your business (e.g. a traditional bank loan) is investing either your own money (if you have it) or someone else's money in your business. This is called equity financing. The main difference between debt finance and equity finance is that the investor becomes a part owner of your business and shares any profit the business makes.
The main sources of equity capital are:
- family and friends - an important source of equity for new businesses
- business angels - wealthy individuals who invest their own funds (typically up to $2 million) into start-up businesses with strong growth potential
- venture capitalists - professional investors that invest funds (generally $2-10 million) in operating companies with high growth potential
- public float - raising money by issuing securities (e.g. shares) to the public.
Advantages of equity financing
- Freedom from debt - unlike debt finance, you don't make repayments on investments. Not having the burden of debt can be a huge advantage, particularly for small start-up businesses.
- Business experience and contacts - as well as funds, investors often bring valuable experience, managerial or technical skills, contacts or networks, and credibility to the business.
- Follow-up funding - investors are often willing to provide additional funding as the business develops and grows.
Disadvantages of equity financing
- Shared ownership - in return for investment funds, you will have to give up some control of your business. Investors not only share profits, they also have a say in how the business is run. While this has advantages, you need to think carefully about how much control you surrender.
- Personal relationships - accepting investment funds from family or friends can affect personal relationships if the business fails.
- Time and money - approaching investors and becoming investment-ready is demanding. It takes time and money. Your business may suffer if you have to spend a lot of time on investment strategies.
- Learn more about raising public funds for your business.