What is Equity?
Generally, equity means the value of assets you own after clearing off your debts. But according to startups, equity refers to venture capital funding and equity compensation. Venture capital financing is offering a part of your firm in exchange for funds while equity compensation is offering your employees stock options as an extra income. The employees can sell the stock options at a later date in exchange for cash.
Importance of Equity
Equity is essential since it has value. It can be used as a form of exchange to get what a company wants, in this case, it can be excellent employees and funds. However, once you do this, you no longer own 100 percent of your company.
Equity Financing Value
With equity financing, you can give out a share of your firm for money. While you don’t own the whole of your company, you have earned cash that you lack the legal obligation to repay to your investors. The value of this cash can be more significant that owning your whole company. If you are in the growth stage of your company, you will need this cash.
Cash allows you to recruit new employees, allows investment in marketing, buys new equipment, and more. Exchanging a share of your company for money also has other benefits. Venture capital firms own a share of your company, which means that it’s in their best interest to advise you on ways to grow your business and beat various challenges.
Pitfalls of Equity Financing
Offering stock options to your staff can adjust your equity. But this does not mean that the staff can tell you how to operate your business. However, this is not the case with venture capital firms. These firms may want to have a decision in the operations of your business. They may also want a portion of the profits you make.
Comparison between Equity Financing and Debt Financing
Some businesses are of the opinion that bank loans are preferable to equity financing. Debt financing can be a good option, but it has some hidden traps. The more debt you owe external parties, the less the value of your equity. Here is how equity financing and debt compare:
• In equity financing, you offer cash in exchange for equity in your company. In debt financing, you borrow money from a private lender or a bank.
• In equity financing, money frequently has strings attached. In debt financing, you can use the cash as you wish.
• In equity financing, the money you receive is returned in the long run, and you can get equity back, depending on the agreement. In debt financing, you keep all your equity but you owe the sum borrowed, and in case of cash flow problems, you may face challenges with debt repayment.
• In equity financing, you get advice and business help in addition to cash. In debt financing, the financial institution only cares about timely repayments.
Another Alternative: Convertible Debt Financing
This equity finance option is rarely discussed. In this case, you receive money from the investor who expects equity at a later date. This is also referred to as a convertible loan. This option is normally offered by investors who believe that your company will have more value in the future. This kind of financing essentially needs a lawyer.
When to Consider Equity Financing
When you want to grow your company, equity financing is an ideal way. But at times, you might have to go with it because you lack a good credit record. When you have bad credit, you can face challenges in obtaining a loan. This option is also ideal when you need external assistance. When you want help that is too expensive for you to hire, an equity investor is normally a better option than debt. Additionally, there might be concerns about repayments since banks require monthly repayments. Failure to meet these payments can bankrupt your business. Therefore, it becomes ideal to go for equity partners who are not looking for short-term gains but are looking for long-term benefits.
Equity financing is always a good option due to its flexible repayment terms and business support. Grow your business with equity financing.