What Is Equity Financing
Equity financing is the act of raising money for capital by issuing shares to small investors. In return, investors enjoy ownership rights in the corporation. This is a popular way to raise capital for any new project launched by the company. Mostly those projects can be taken to public which directly affect the life of the common people. For example, power projects, housing projects etc. can attract a lot of capital from individual investors.
Equity financing is a risky affair because its success largely depends upon the interest of the investors. Many a times, investors do not like certain business models and so even ownership opportunity does not excite them. It is found that only 0.1% to 0.2% of funding requests result into investments.
Most of the entrepreneurs do not incur much time and money to share their business plan with the external investors. Since there is no secured guarantee of getting the returns to the investment made, companies attract the investors on the basis of their proven track records. Equity financing is the way of making up for losses made by investors under other heads. A successful project is expected to give them a return of at least 40% annually.
Entrepreneurs go for equity financing because they are over-optimistic about the success of their project. Due to this, projections presented to financers may be no more than a rosy picture, thus resulting into losses to external investors.
Uncertainty of the success of the project is the biggest risk involved in equity financing. It is advisable to companies to rely on the available resources than depending entirely on external funds. Searching for funds is a time consuming process. It requires few months’ time to start the project if funding is largely based on external investors. This time lag can increase the cost of the project manifold thus extending the break-even time to few extra years.
Private companies opt for venture capital which is a form of equity financing. Venture capitalist is able to provide his expertise and experience to the project, in addition to, money. He is entitled to a portion of equity in the company, thus partnering both risks as well as rewards. Venture capitalist also extends his experience of the times when he was in similar stage of the business cycle.
Equity financing should be planned very carefully. It should be clearly envisioned how much equity should be given away while keeping company’s control in own hands. Equity financing is mostly a long term investment with no involvement of interest unlike debt financing where money raised is to be repaid with interest. Keeping risk and uncertainty in mind, investment should be made after studying the company profile meticulously irrespective of the type of funding.