Equity is the portion of money invested in a business that is not debt. Equity as an investment is a long-term commitment. For an investor it also carries a higher degree of risk than a loan, since it is normally secured by business or other assets. Investors offer equity with the expectation of sharing, as owners, in the profits of the business.
You can use equity for a number of activities:
- product development
- starting a promising new business
- expansion of an existing venture
- financial aid to an ailing business
- purchasing an existing firm
EQUITY OR DEBT
There is no simple answer on when to choose equity or debt, or how much to invest. Management Consultants and financial advisors can assist you in determining which source of financing is the most attractive at a given time.
A prime advantage of equity is that it does not increase a company's debt load. If additional loans are needed your company's borrowing ability has been increased; less debt improves a business's credit rating. Non borrowed capital does not negatively affect a company's cash flow by requiring regular installments of principal and interest and often the business risks are spread out among several investors.
There also are disadvantages. You will have to share control of your business with the equity investors and you will also have to share the profits. The costs of drawing up a partnership agreement or incorporating your company and fees for record keeping and issuing dividends are additional administrative, professional and legal expenses that may be incurred.
Originally equity capital for your business will probably have to come from your own savings. If you require more money than you can raise on your own or borrow from a lender, you may need to add partners. Your partners must agree with you on how the daily work, management decisions, and profits of the business are to be shared.
You can also gain equity by forming a limited company. Your business gains the ability to sell shares publicly. Most owners incorporate their business as private companies. These private companies operate under government regulated restrictions as to the number of shares allowed and how they may be issued, sold or transferred. The company is controlled by the shareholder holding the majority of the voting shares.
SOURCES OF EQUITY
Small business owners have access to a number of private and non-private capital sources. Personal contacts are the most popular but you may wish to approach outside investors such as venture capital firms. Equity pools are often administered by financial institutions or investment groups who specialize in investing in businesses with growth potential and an ability to produce returns on investment.
A larger company may want to gain control over a smaller competitor, purchase an interest in a new development process, or acquire additional clientele. This may be a source of equity for the smaller, expanding firm.
Equity usually comes with disadvantages. Consult a Management Consultant or your professional advisers to ensure this financing technique will not apply undue or unexpected restrictions on your ability to operate your business.
Seek equity before the need becomes urgent or you will be bargaining at a disadvantage and possibly be subject to unattractive conditions.
When you approach investors offer a carefully prepared proposal. Present your case for funds in a convincing and professional way. In as much detail as possible indicate how the new funds will be used supporting your argument by presenting accurate balance sheets and operating statements.
Demonstrate your own management ability by presenting realistic information that will convince potential investors that this is an investment opportunity; that you and your company are at least as attractive as other available investment options.
If you approach outside investors wisely you may obtain the necessary equity as well as invaluable business partners who can bring their expertise into your business.
