CHAPTER FIVE: Part C – Before jumping into the game of raising capital, it is very important that you critically weigh the odds of seeking external small business financing. Having looked at the advantages and disadvantages of debt financing for small businesses, let us now do the same for equity financing.
- You can use your cash and that of your investors when you start up your business for all the start-up costs, instead of making large loan payments to banks or other organizations or individuals. You can get underway without the burden of debt on your back.
- It’s less risky than a loan because you don’t have to pay it back, and it’s a good option if you can’t afford to take on debt.
- You tap into the investor’s network, which may add more credibility to your business.
- Investors take a long-term view, and most don’t expect a return on their investment immediately.
- You won’t have to channel profits into loan repayment.
- You will have more cash on hand for expanding the business.
- If you have prepared a prospectus for your investors and explained to them that their money is at risk in your brand new start-up business, they will understand that if your business fails, they will not get their money back.
- Depending on who your investors are, they may offer valuable business assistance that you may not have. Yes, I have seen quite a number of angel investors and VCs assume the role of business advisors or even coming on board fully as part of the management team. This can be important, especially in the early days of a new business.
- Maintaining a low debt-to-equity ratio also puts you in a better position to get a loan in the future when needed.
8 Disadvantages of Equity Financing
- The investor will require some ownership of your company and a percentage of the profits. VCs often request an equity stake of 35% – 51%, especially when you are just a startup company with no strong fundamentals. You may not want to give up this kind of control.
- You lose the sole control of your business, since your investors also own shares in it. It is also important you know that your investors can come together and vote you out of the board, thus making you lose control of the company you started. This can be a very painful experience for you.
- An example of such incident is the case of Apple, when Sculley led the board to a revolt against Steve Jobs and Jobs was kicked out of the board. It may interest you to know that it was Steve Jobs that lobbied and poached John Sculley from Pepsi.
- Equity investors require a greater share of your profits than interest on a loan.
- Your investors have a legal right to be informed about all significant business events and a right to ethical management.
- Your investors can sue you if they feel their rights are being compromised
- In the case of irreconcilable disagreements with investors, you may need to cash in your portion of the business and allow the investors to run the company without you.
- It takes time and effort to find the right investor for your company.