Advantages and Disadvantage of Equity Financing

Equity finance can be used by businesses at any stage of development. It can be especially beneficial for startups or new businesses, those who want to make a large investment, or others that may struggle to get a loan.

However, equity financing comes with drawbacks, and may not be the most suitable solution for your funding needs. It’s therefore crucial to evaluate the advantages and disadvantages of equity financing before deciding whether or not it’s the best option for your business. 

What is equity finance?

The term “equity financing” refers to the practice of raising capital for a business by selling a share of the business. Think of it as Dragon’s Den style investment, for example you might sell 20% of your business for £100,000. 

These shares are often referred to as equity. Investors who purchase equity in this way are often known as shareholders. Depending on your arrangement and how much equity they own, they will be entitled to a share of the profits and have a say in business decisions.

Advantages and disadvantages of equity financing

Advantages of equity finance

No need to repay the money

Unlike loans, which have to be repaid with interest, equity finance does not need to be repaid. Instead the investors hope to make a profit through the ongoing success of the business and the share of profits they will receive from it. 

Potential to access wider expertise and connections

Equity investors will often be experienced business people or dedicated investment firms with lots of connections. What’s more, they need your business to thrive for them to make a return on their investment, so will likely offer advice, expertise and contacts to help your business progress. 

Potential access to significant capital

Equity financing can help you gain a much larger amount than you would be approved for in a business loan. Whereas loan providers will typically look at your current operating level to see what you can afford, an equity investor will look at the potential of your business over 5, 10 or 20 years. As a result, they can be more willing to take on the risk of investing larger amounts.

Disadvantages of equity finance

Reduced future profits

Using equity finance will give you a one-off injection of capital. The price of this, however, is that you will have to give up a share of your future profits indefinitely, as the equity investors will continue to take their share until you can buy them out (if that is possible).

Dilution of ownership rights

As well as giving up profits, you also give up a level of control. Business decisions will have to be made with all shareholders in mind, and depending on your arrangement, they can have a significant say in key decisions.

You will have to take other people’s opinions into consideration regardless of whether or not you agree with them. The same holds true for other investors. This can lead to conflict, which you may have to manage.

You will also need to recognise that investors can sell their shares in your business to other people. This can lead to you having to deal with people that you might not have chosen to include in your business.

Increased administration

In addition to having to manage basic financial filings, you will need to deal with the practicalities of keeping everyone adequately informed and engaged. In some cases, this will require you to fulfil legal obligations. These can change so you will need to keep yourself informed of any and all relevant laws.

Alternatives to equity finance

The advantages and disadvantages of equity financing must always be assessed in comparison to a company’s other options. The two main alternatives to equity financing are self-financing and debt-financing like a business loan. Crowdfunding and grants may also be options.

How to decide if equity finance is right for you

At the end of the day, the advantages and disadvantages of equity financing have to be viewed in the context of what is right for you and your business. Generally, the starting point for this is looking at your business goals and considering if equity financing aligns with them. 

If it does, you then need to think about the practicalities of attracting investors, and any legal or regulatory requirements you’ll need to adhere to. Seeking independent advice from trade bodies, mentors or others who have been through the process could help you understand exactly what’s involved. 

If you decide equity finance is not for you, we may be able to support you with a fast, fixed-rate business loan or flexible line of credit. You can check your eligibility in just 30 seconds here.