Equity is an ownership term. Company equity value is set by subtracting what you owe from what you own. A company owner may give up equity in a company by partnering with a companies offering money to small companies. These are called venture capital firms. In other cases, a company may choose to issue shares in the company through a stock offering.
Issuing stock changes a company from being private to being public. Public companies get more attention paid to them because they answer to shareholders. Venture capital companies may limit how a company uses the money they invest while there may be fewer restrictions placed on money raised through a stock offering.
Why is equity important?
When a company needs money, equity financing is a possible option. Rather than taking on debt, a company will issue a public stock offering or look for funding from venture capital firms. With a public offering, people or businesses buy shares in the company and the company gets the money they need for growth. With a venture capital deal, the company gets money in return for a share of the company.
Equity financing allows companies flexibility. Hiring, buying equipment or real estate all allow for company growth without ending up owing money. Owing money means you have to pay that money back on a regular schedule, so equity financing is often a better option.
When to avoid equity financing
Equity financing is not without its problems. Owners who think about equity financing face:
- Loss of independence – shareholders own the corporation and have a say in how the company operates. Transactions involving venture capital money mean the company providing the money has some control.
- Sharing the money you make – the money you make is shared with shareholders; the cost of asking for public money. Venture capital companies will also want a portion of the money you make in exchange for the money they give you.
- Conflicts with shareholders – shareholders have a say in major decisions, which can lead to conflict. Conflicts can also happen with venture capital partners.
Companies should avoid equity financing if they wish to keep control over the day-to-day operations of their company.
When to use equity financing
Equity financing is not a good idea if you wish to keep control over your company. But, there are advantages. When deciding between owing money and equity financing, some things to think about include:
- Credit worthiness – one need not have good credit to get equity financing. This is often a deciding factor.
- Repayment considerations – equity financing does not have to be repaid. Bank loans can take years to pay and can stunt the growth of a company.
- Knowledge and experience – when a company needs outside help to get specific things done, an equity partner may be able to share what they know. This is true with start-up money compared to a public stock offering.
What happens when you use equity financing?
It is important to understand the results of getting equity financing. The effect on your company can be significant.
Venture Capital Financing
You decide on the amount of shares to be issued and the money you raise depends on the number of shares and the cost.
Company offers a fixed amount of money in return for a fixed share of the company.
Funds are obtained from many people to help your company. This limits the day-to-day control they have over the company.
Often require companies to add board members or advisers as a condition of providing money.
Sales points must be met before offering stock to the public.
Will want to withdraw as soon as the company reaches a specific level of earnings.
What happens if you elect to avoid equity financing?
When your company is short on capital, you may be unable to accept new contracts, buy new equipment or make new hires. Should you decide against equity financing, you will be forced to borrow money which will require repayment and may have strict requirements on usage.
One advantage to borrowing money is you will not have to give up any control over the management of the company. This can be a plus for those business owners who wish to maintain complete control over operations and decision-making.
Common mistakes made with equity financing
Whether your company is thinking about a private equity option through a venture capital firm or a public equity placement through a stock offering, there are some common mistakes that are made including:
- Not enough record keeping – clear records of income and expenses will be needed no matter what the method of getting equity financing may be.
- Reasonable time frames – it takes time to raise money; companies need to start the process early enough to meet their goals.
- Expecting something for nothing – whether you are seeking public or private equity money, it will cost you money. You may need a business plan, audited financial statements or other expensive processes.
- Not knowing your target – when you are thinking about private equity financing it is important to know which companies handle what businesses. Not every venture capital firm handles every type of investment. With a public offering, you need to have a solid understanding of the real value of your company.
- Trying to go it alone – you need a legal adviser to help you through these processes. Both types of equity financing must address certain legal needs and you do not want to try to figure them out on your own.
Frequently Asked Questions
What types of companies secure Venture Capital Funding?
In most cases, venture capital firms invest in particular businesses. These investments are more suited to companies who are in their middle stages of growth. Venture capital is usually not right for start-up businesses; instead, venture capital often bridges the gap between company growth and their ability to participate in public stock offerings.
What is needed to take a company public?
There are some things that are needed to take a company public. To list a company on the New York Stock Exchange (NYSE), a company must show $10 million in pre-tax earnings over the last three years and a minimum of at least $2 million in each of the two latest years.
Companies listing on the NASDAQ Global Select Market need pre-tax earnings of more than $11 million total in the prior three years and more than $2.2 million in each of the latest two years. There are lesser exchanges for taking a company public sooner, but in most cases, these are the minimum necessities.
Do I have to make reports?
A venture capital firm will require regular reporting about your company's financial standing, including cash on hand, debts, new equipment, staff changes, etc. The Securities and Exchange Commission (SEC) will require regular filings by the company and additional shareholder disclosures. Your attorney can advise you of all legal requirements before you determine which method of equity financing is right for your business.
Before you get involved in any equity financing, it is extremely important you work with an attorney who understands the markets. A lawyer can help with all necessary documents. You may have to provide certificates of incorporation, a completed business plan and may need to have other legal documents prepared.