At the beginning of 2021, one of our Oil and Gas Industry clients asked us to secure funding for their group of companies, three of which were new businesses. The first thing we needed to establish was what type of funding would be best for them: equity or debt financing.
As this seems to be a recurring matter, and although last year we touched briefly on how to secure appropriate funding, we believe this is a great opportunity to discuss equity and debt financing in more depth over the following weeks. So, let us start with equity funding as a capital strategy.
Equity financing is a method of raising capital by selling shares of the company. This method of financing is available to new businesses in need of cash or those seeking to expand. Once a business opts into equity finance, it gives up some aspect of ownership to the investors.
Although equity finance can also come in the form of personal investment from the owner of the business, there are other sources of external equity finance. These include:
Angel investors: These are individuals that invest in small businesses to help them get off the ground at the initial start-up stage. It is usually one-time support with flexible terms and conditions. Angel investors are usually people with high net worth and they exchange their support for ownership in the business.
Venture capitalists: These are professional investors who fund growing businesses and, like angel investors, they usually require equity from the business or company they are funding. A venture capitalist is selective with the type of business to which they offer financial backing, ie they target companies with high potential for expansions, such as tech companies. This is because they expect huge returns on their investment, which is usually more than that of angel investors.
Corporate investors: These are incorporated businesses that invest in another company. The motive may be to generate additional revenue by investing in another company that shows great potential for increasing its business volume or to gain control of a business by buying most of its stock.
Crowdfunding: This is a form of equity where capital is sourced in small units from donations made by many individuals. It takes advantage of online platforms, where a pool of investors can fund businesses.
Friends, family, and colleagues may also be a source for providing external equity finance to a new business.
While equity as a source of finance has the advantage of flexibility in terms of accessibility and repayment options, it also has the following disadvantages:
Loss of control: most investors exchange financial backing for ownership of the business. At the end of the day, an entrepreneur might not have so much control of his or her business.
Time-consuming: entrepreneurs spend time looking and trying to convince investors, which might distract them from the core business.
A high level of accountability to investors: potential investors will require information regarding every aspect of the business and that is why you need to have a good business plan.
Source of conflict: Having many investors in a business can result in conflict, especially during decision-making, (too many cooks spoint the broth).
Depending on the type of equity finance a business considers, a strategy must be established to ensure it aligns with the objectives of the business in the long run.
At OVAC Group, we can work with you to select which equity finance option will yield the highest value and pose a low risk to your business. Email us at firstname.lastname@example.org.