Equity Financing : Advantages & Disadvantages

  • July 18, 2016
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A company can finance  its operations by using equity, debt or both. Equity financing is a method of financing in which a company issues shares of its stocks in order to raise money/capital. It refers to the sale of an ownership interest to increase funds for business purpose.  It is necessary for a business as air is necessary for a person. However, debt financing means to raise capital by financing loan from the bank and other financial institutions. The purpose of both operations is same for raising funds.

Equity financing involves a number of activities in scale and scope. In this, venture capital is one of the most popular forms of equity financing. As, it is used to finance high-risk and high-return businesses. When the investment occurs, it holds the perceived risk, the amount invested, and the relationship between the venture capitalist and the entrepreneur. These types of capital, usually invest in every kind of business. Venture capitalist are also known as angels because the angels do want to have a say in strategic planning in order to reduce risks and maximize profits if they don’t dynamically participate in the daily management of a company.

Whether a company use equity, debt or both types of financing, the lender’s point of view also plays a role. If equity is higher than debt, the lender will feel more secure. However, the company’s ratio of debt to equity will power a lender’s willingness to lend. But, if debt is higher than equity than investors will be encouraged.

Advantages of Equity Financing:

The main advantage of equity is that it need not be paid back. On the other hand, bank loans or other variety of debt financing has an instant impact on cash flow and carry harsh penalties unless payment terms are met.

It is more probable to be available for new businesses or startups with good ideas and sound plans, as equity investors primarily seek opportunities for growth.

Equity financing is the only source of financing, as debt financiers seek security. They required some kind of track record before they will make a loan.

Disadvantages of Equity Financing:

The main disadvantage of equity financing is an issue of control. In this procedure, a person that owns 51% shares guaranteeing absolute control.

Some sales of equity, such as limited initial public offerings, can be complex, expensive, inevitably consume time and require the assistance of expert lawyers and accountants.