Funding is the mainstay of any business, whether big or small. The needs of a company may vary, ranging from short-term to long-term. Equity financing is the method of raising capital by selling the company’s shares to investors. By purchasing the company’s shares, investors obtain ownership rights of the company. Equity financing involves the sale of all equity instruments like common stock, share warrants, etc.
Fundamental sources of equity finance
There are eight fundamental sources of equity finance: self-funding, family and friends, angel investors, venture capital firms, corporate investors, initial public offering (IPO), crowdfunding platforms, and the government.
Let us understand them in more detail.
No investor would be willing to put their money in your business without you having made any monetary contribution towards your initiative. The other name for self-funding is bootstrapping. It involves funding from the pool of financial resources based on a comprehensive asset valuation that you may have at your disposal. Self-funding may include directing finances from your savings, business revenue, etc., toward your venture.
This first move that you make helps to show your unflinching dedication, steely determination, and unwavering passion for your goal. It creates a strong impression in the eyes of your future investors and can benefit you directly during valuation for mergers and acquisitions. So in this regard, we may easily say self-funding is the stepping stone towards realising your bigger goals as it lays down the foundation for seeking financial support from investors.
2. Friends and Family
Including people you already know as partners in your business may sound like an ideal thing to do. This is also one of the easiest ways to get finance in return for equity. But this decision may have its cons too. Business and finance are the two most complicated things that can make or break relationships. So you must be very careful before making such a decision.
Whoever among your family, or friends you would like to include as a part of your business, make sure to have a dialogue with them at length. Once both the parties are convinced and aware of the flip side as well, you may go ahead with the decision.
3. Angel Investors
Angel investors are also known as seed investors, private investors, or angel funders. They are a group of wealthy individuals who provide financial support to small start-ups. These investors put their money in those companies where they see very high growth potential after careful asset valuation. This is like a win-win situation for both the company and the investors.
While the investors purchase stakes in the business, which gives them ownership rights, it allows the entrepreneurs an opportunity to partake of the investors’ valuable business skills and expertise. Angel investors could also be a part of your family or friends.
4. Venture Capital Firms
Venture capital firms raise their capital from limited partners. These are a kind of investment firm that usually backs enterprising start-ups, like tech-oriented companies. They invest in those companies because they believe the young start-ups would do very well in the future. However, compared to angel investors, the amount the venture capital firms invest is much larger. As a consequence, their stakes in the company are also higher than the angel investors.
5. Corporate Investors
A corporate investor is usually a large company that invests in a smaller company by providing required funding to the same. This investment is aimed at establishing a necessary partnership between the two business entities. Not only is the financial return on these investments by large companies beneficial, but the large corporations can monitor changes taking place in their target market industry and hold sway over them. Such Investment by large corporations in small start-ups is known as Corporate Venture Capital (CVC).
6. IPO/Stock Market
An initial public offering (IPO) allows a company to raise capital through public investment. Any well-established private company can make its shares available to the public through an IPO. Generally, the price band of the IPO is determined by asset valuation (including plant and machinery valuation), insurance valuation, or the valuation for mergers and acquisitions.
An IPO also marks the transition of a company from private ownership to public ownership. By trading the company’s shares in capital markets, the public can help companies raise their funds. But to hold an IPO, a company must fulfil all the guidelines laid down by the Securities and Exchange Commission (SEC).
7. Crowdfunding Platforms
Crowdfunding is different from the above in a way that instead of inviting large investments from a small group of investors, it attracts moderate contributions from a large group of individuals. Crowdfunding is a process of funding where people usually invest in promising companies with high insurance valuation estimates in the hope of gaining profitable returns in the future. Crowdfunding is done online through websites. These websites offer a platform for promoting a business idea. When people find this idea beneficial and lucrative, they donate toward the cause.
Crowdfunding can be of four types. Each one is different from the other because they have a separate way of raising funds. From the investors’ perspective, each type involves different tax formalities. The different types of crowdfunding are as follows:
- Donation-oriented crowdfunding – Sometimes, there are one-time projects for which contributors may donate money without expecting or receiving anything in return.
- Reward-oriented crowdfunding – To get people interested in their projects and motivate them into investing, businesses sometimes offer rewards in the form of goods, services, or discounts. Taking the amount of contribution into consideration, the companies normally offer their products either for free to the donor or at a discounted price in the future. Also, as a thank-you gesture, they may acknowledge the contributors’ payments on their websites by putting up their names and the amount they have contributed.
- Equity-oriented crowdfunding – This form of crowdfunding that is motivated by equity is also known as crowd-sourced funding. Small to medium-sized businesses with significant plant and machinery valuation figures are known to benefit from this type of funding. When the companies circulate their shares in the market, numerous people invest in those shares. The amount they shell out in purchasing those shares is usually small, but they become stakeholders in the company in return.
- Debt-oriented crowdfunding – In this type of funding, the investors are replaced by lenders. The businesses borrow money from these lenders to expand their business or invest in more advanced technology. This arrangement is more like taking a loan. The business has to pay interest on the borrowed amount as well as repay the principal amount.
You may not be eligible for funding from the government when you are starting your business or acquiring new companies without a proper valuation for mergers and acquisitions. But you may qualify for a grant to carry out the following:
- Research and development that will take your business to new heights.
- Innovation and expansion of your business.
- Tap into the overseas market as a potential buyer for your goods and services.
Equity finance is beneficial in more ways than one.
- It offers an alternative funding source, especially for start-ups that are not eligible to apply for bank loans that accrue to large sums of money.
- It allows better scope for company management because some investors may be willing to stay personally involved in the organisation’s functioning.
- Most of the influential investors have access to better contacts and other sources of capital which may prove invaluable to companies that are new in the fray.
- This, in turn, provides more opportunities to share views and ideas, resulting in the company’s overall growth.