Financing – Understanding How Equity Financing works

Financing is a term used to describe the act of making funds available for business activities, for purchasing or making an investment. With the help of financial institutions like banks, many business projects and otherwise are achieved. They raise capital for consumers, investors, and businesses. This system has made companies purchase products out of their immediate reach.

On several occasions, financing is the act of putting to use the money over a money generating project for more returns. To some, it is an acquisition of money to undertake investments, thereby creating a market for the money.

WHAT YOU SHOULD KNOW

  • Firstly, do you know that financing is one way of funding business activities and making purchases or investments over time of cash need?
  • Secondly, do you know the types of financing are of two kinds? Equity financing and debt financing.
  • Thirdly, equity financing in return has no obligation for repaying the money acquired under equity financing.
  • Furthermore, do you know that the financial burden is lifted off the company? Even as that, many more disadvantages are attracted.
  • Generally, you get debt financing relatively cheaper with tax breaks. On its side, the disadvantage is attracted as a result of a debt burden on the company. This can cause default and clear credit risk is faced.

Like I mentioned earlier, there are two main types of financing available for companies. They are debt financing and equity financing. Debt financing is paid back with interest oftentimes, relatively cheaper. But in equity financing, there is no need or call for payback but places ownership stakes to the shareholder.  Most importantly, they both have advantages and disadvantages it serves to the companies.

How Equity Financing works

From the name “Equity” you can derive what it is talking about. It simply means ownership in a company. A company can decide to go for equity financing to grow operations by staking 10% of the company for $100,000, valuing the firm at $1 million. Assuming the business falls, the investor bears the risk because he gets nothing.

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Over here, investors give his money to a company for shares in order to receive some claims on future earnings. The investors often take the risk because if eventually, the business falls, then they gain nothing.

Advantages of Equity Financing

  • For every company, the greatest advantage is that it does not require to pay back the money. When the business runs into bankruptcy, the investors are not owed unlike the creditors in debt financing. They partner as owners and as such when the business crumbles, they are as well affected in the loss.
  • There is no need for the monthly payment and this makes you often have money at hand to operate.
  • With the mindset of investors, they understand that businesses take time to grow, they live to allow the business to grow without pressures by lending them money.

Disadvantages of Equity Financing

There are couples of the number of disadvantages you get on equity financing.

  • Equity financing makes it that the creditor. Owns a part in your business. Investors will want to make the investment. Riskier to attract more of a stake the investor will want. You may get to give up 50% or more of your company unless you decide to construct a. Deal ‘to buy the investor’s stake. Failure to do that. The investor will definitely take the 50% of your profits.
  • There is always a need to consult the investors. Before making decisions. You will also have to consult with your investors. Before making decisions. This is because your company. Is no longer own by you alone. Thus, it gets worst when the investor has a. Higher percentage of 50% of your company. Then he is a boss you are answerable to.
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Debt Financings

This type of financing seems more familiar and. Particular to car loans and mortgages. Debt is a way to also finance business. It is totally the opposite of what you get with equity. Debt financings must. Be repaid and most often, with an interest rate in exchange for the use of their (Lenders) money.

At times, lenders desire to have secured financings by employing the need for collateral. Debt is easier to obtain to rescue you of your current need, most importantly when it calls for collateral. In as much as debt is paid back, the business still remains solely the owner and thus, has no quarry for taking the decision on their own.

Advantages of Debt Financings

  • The company is not influenced by the creditor in terms of making decisions that concern their company. The lender should have no control over ownership.
  • After payback, you can choose to end. The relationship with the lender. In most cases. Iit is a result of the value of the business currently.
  • The interest you pay on the debt. Financing is tax-deductible, unlike equity.
  • You are leveraged of the monthly. Payment in addition to breaking down the payments.

Disadvantages of Debt Financing

  • It gets you more handicapped over monthly expenses whenever the cash inflow is available to settle off debt payment and other expenses. There is also uncertainty for small businesses to handle the debt payment with other expenses.
  • For a recession, it is difficult to offer small business loans and it also to receive debt financing unless under considerable circumstances.

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