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What is Equity Funding?
Equity funding is a type of funding in which individuals are given shares in exchange of their cash investment. For startups, it becomes quite a task to raise the much-needed funds to sustain them and grow – by using equity funding method; they are able to get funds from investors who in return get shares in the startup/company.
Another definition of Equity funding explains it as special type of mutual funding or private investment funding in which investors get ownership of the business.
The number of shares depends upon the investment an individual does in the startup/company. In equity funding, the investors also share the benefits if the startup/company becomes successful. These benefits can be price hike in the share value, increase in the startup/company value in the market, profit over the sales of product/services.
“Investors located in Northern Ireland, North West, Wales, North East and London invest most of their funds in their home region.”
– Equity Finance and the UK Regions
Who can be an equity investor?
While previously there were only a few limited ways a company could get some extra cash, i.e, taking a loan from bank or loan sharks, with equity funding the landscape has changed drastically. Typically, anyone can become an equity investor:
Friends of the founder
This again is a popular methodology when it comes to equity funding. Taking investments from your friends who are credible and can trust you can help in avoiding the formalities that come with taking investment from venture capitalists or companies.
Family members of the founder
If you are blessed with family members who have money to invest in your new business, this can be a great option, but it does come with a downside. If for some unfortunate reasons the business does not boom enough or takes longer time, it might jeopardise your relationship with them.
- Angel investors
Angel investors are vastly different than venture capitalists. They are usually successful entrepreneurs themselves. They have more flexible terms and conditions while investing in your business.
- Angel networks
Angel networks comprise of a number of angel investors who they find trust-worthy. These networks invest in emerging businesses and get equity in return.
- Crowd (by using crowdfunding platforms)
Equity crowdfunding has become quite popular since it was first introduced to the world. Anybody can invest in a business according to this model. It is similar to any Kickstarter project, but instead of getting products/services, investors get equity (share) in the company.
- Venture capitalists
To impress a venture capitalist to the point that they actually invest in your business is not easy. It is a highly competitive world when you are looking for equity funding from venture capitalists but once you are successful in doing that, you get impressive amounts of money to take your business to the next level.
According to the figures shared by Bank of England, some 61% of businesses are launched with either personal capital or that of friends and relatives. That can be equity arrangement where friends and family take a stake in the business.
Equity Funding vs Debt Financing
When you are starting a business or have reached a point where you require investment from a third-party and take business loan from a bank using a credit card, it is called debt financing.
The creditor (the bank) will not have any control or equity in your business. You will simply have to pay back all loan along with interest to the bank. If everything goes fine, this is a great way to go forward but problem occurs when you are unable to return it all back.
It might come as a surprise but more companies file for bankruptcy when they cannot return back their business loan than any other reason.
Once you are unable to deposit the fixed amount of money back to the bank, the case goes to court and they can seize your assets and business. You might end up losing more than you originally bargained for. While this scenario seems quite haunting, it is important to know what can happen if your business is unable to make the profit or revenue you thought it would.
To avoid this situation, business go for the second route; equity funding.
How Equity Funding is different
On the other hand, when you go for equity funding – the variables change altogether. You no longer have the fear of going bankrupt because you were unable to pay back the business loan to bank.
If you get funding from your investors but are unable to generate enough revenue to keep the business afloat, you would not have pay anyone anything back. On the other hand, if your business booms – investors will also be entitled to the profits that you generate.
As long as the investors have a share in your business, they will share the profits with you.