How much do you understand about the ways of financing your business? We all know that we need to get enough capital (Also see An Overview of Capital Expenditure) to fund our daily business operations, and when we want to expand our company, hire more employees, or to manufacture new products, we need more funds. This is when we need to obtain more capital (Also see How to Differentiate Working Capital and Fixed Capital?) for our company.
Generally, business financing can be divided into two main types, which are debt financing and equity financing. The former means that a company borrow money and it needs to repay it in the future. On the other hand, the latter refers to a situation where the company sells its equity to obtain funds from the investors. Both methods will affect the financial statements of the company in different ways. If you are not familiar with accounting, do not hesitate to hire an accounting firm in Johor Bahru and let the professional accountants do necessary records and adjustments after the financing of your business.
In this article, we will shed light on the second type, which is equity financing. Before we start discussing equity financing, let us have a look at what is meant by equity. This is the term that refers to the number of assets the investors will obtain once the company has paid for all debts. This can be proven by the accounting equation, which states that the company’s total assets are equal to its sum of liability and equity. If we derive the formula, we will be able to calculate equity by deducting liabilities from assets.
In general, business owners will opt for equity financing if they need cash for a short term. This means that they will not choose this form of financing for long-term financing. Equity financing is a type of business financing that is common among startups, where during the evolution of the business, a few rounds of financing may take place.
If you own a small business, there are a few types of equity financing you may choose from. One of the most common methods is via venture capital. This kind of firms tends to invest in the newly incorporated companies that have excellent growth potential. If you want to receive venture capital, you need to prepare information related to the growth potential of your business, as well as the business plans that you may carry out in the future. Typically, venture capitalists will only be interested in companies that have the potential to grow rapidly so that they can earn a high return.
As venture capitalists may get involved in the business operations, some business owners may not prefer it. An alternative is to look for angel investors. Usually, these angels are wealthy persons that intend to invest money into a business in exchange for healthy profits. They may provide input without getting involved in the business operations of a company.
Business owners who choose equity financing will definitely benefit from it in a few ways. By choosing equity financing, they do not need to repay for loans so that they can reinvest the money earned back into the business. Also, equity financing is a better option for business owners who are lack of credit history. Having a poor credit history can make the process of debt financing to be more difficult. In this case, equity financing will be more suitable for them.
Besides, if business owners go for debt financing, the lenders will not get involved in the business operations of the company. If they choose equity financing, on the contrary, the investors will participate in your business operations, and they will be a good source of helpful contacts and advice. This means that they will help in building and growing your company as they normally will spend time and skills in developing your company.
On the flip side, in debt financing, the investors have bought part of the control of your company, and this may cause issues regarding control of the company to arise. This will occur when the investors have different ideas on the company’s operation or decisions, where their point of view is not the same as the company’s management opinion. Also, as the investors have part of the ownership of the business, they deserve a share of the company’s profit. Hence, business owners need to distribute the profits earned to investors in the form of cash or dividend.
In a nutshell, business owners should look into the details of each type of business financing and the impact they will bring to the business. This is for them to make the decision that suits the company the best for its long-term profitability and sustainability.