Equity finance is share Capital invested in a business for the medium to long term in return for a share of the ownership and sometimes an element of control of the business.

Unlike lenders, equity finance investors don’t normally have rights to interest or to be repaid at a particular date. Their return is usually paid in dividend payments and depends on the growth and profitability of the business.

Because equity investors share the risks your business faces, equity finance is often referred to as risk capital.

Is it right for your business?
Different forms of equity finance suit different business situations.

Venture capital is most often used for high-growth business destined for flotation on the stock market with shares available to the general public or sale.

Business angles can offer investment, particularly in the early or growth stages of development, in return for equity.

Because of the risk of their funds, investors expect a higher potential return than for safer, more secure investments. Equity Finance is likely to be most suitable Where:

* The nature of project deters debt providers, eg. Banks
* The business will not have enough cash to pay loan interest because it is needed for core activities or funding growth

There are two ways you can finance your business: with debt (borrowed money) or with equity (your and other owners’ own money).Debt refers to any money that your business borrows and is obliged to pay back. Debt is usually obtained from banks and other traditional lenders, but also may be obtained from other individuals. Debts will usually require monthly payments of principal and interest over a fixed period of time.Advantages of debt financing:

You do not have to give up any ownership or future profits of your business. Your lender has no control in how you run your business. All they can require is for you to pay your loan back.

Using borrowed money to obtain business assets will allow you to keep your business profits in the company or use those profits to pay a return to the owners of the company.

Interest paid on the loan is generally tax deductible.

Disadvantages of debt financing:

Your company must have sufficient cash flow to repay its loans.

In most cases you will be using your cash profits to pay back the loans. If your business has a lot of debt, it may end up with a profit but not have any cash to show for it.

You will have to deal with lenders and their criteria to obtain a loan.

The riskier the loan is, the higher the interest rate will be.

Most lenders will require small business loans to be co-signed or guaranteed by the owner(s) of the business.

Loans usually require collateral to secure the loan. If you cannot repay your loan, the lender has a right to seize your collateral.

Too much debt may impair your credit rating and your ability to raise money in the future.

Equity is money that is received in exchange for a share of ownership in the business.

Advantages of equity financing:

Equity contributions do not have to be paid back even if your company goes bankrupt.

Your business assets do not have to be pledged as collateral to obtain equity investments.

Businesses with sufficient equity will look better to lenders, investors and the IRS.

Your business will have more cash available because it will not have to make debt payments.

Disadvantages of equity financing:

You will have to relinquish ownership and a share of your business’s profits to other equity investors.

Other owners may have different ideas than yours on how the business should be run.

Dividend payments to investors in C-Corporations are not tax deductible.

Debt-to-Equity Ratio
A company’s debt-to-equity ratio is the business’s total debt divided by the business’s total equity. Lenders and potential investors will look at this figure to determine if your business is being operated efficiently. If your debt-to-equity ratio is too high (i.e. your business is carrying too much debt), lenders will view your business as high risk and you may have trouble obtaining new financing. Also, if your business has too little equity, lenders may question how committed the owners are to the business.

A debt-to-equity ratio that is too low usually indicates the business is not effectively using its cash and using profits to obtain business assets. This may be discouraging to investors because it will mean less profits being distributed to them.

Lenders generally consider an acceptable debt-to-equity ratio anything lower than 3:1. If your ratio is higher than that, a lender may consider your business too risky to lend money to. However, the industry you operate in will be taken into consideration. Businesses in certain industries (such as real estate and banking) operate with ratios significantly higher than 3:1.

Equity financing is money acquired from the small business owners themselves or from other investors.Stockholders purchasing shares in a corporation, for instance, create equity financing, as do angel investors who provide funding. Small business owners may invest their own funds into their businesses, funds gleaned from inheritance, savings, or even the sale of personal assets which then serves as equity financing for the business.

Besides contributing to a healthy balance sheet, making a personal investment that serves as equity financing in a business is often necessary to attract other investors and/or lenders. If you, as the small business owner, are not prepared to put any of your personal funds into the business, what does that say to anyone else who might be thinking of investing in the business – or that you’re asking for a business loan? Investors and lenders like to see an equity financing contribution of 25 to 50 percent.

Generally, investors and lenders take your equity financing contribution as a sign of your commitment to the business.

They want to see that you are willing to share the risks, as well as the rewards.

While there is a great deal of talk about angel investors as sources of equity financing, the main sources of equity financing for small businesses continue to be family and friends.