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Advantages and Disadvantages of Equity Financing

airplane30902462.jpgThere are several major decisions that must be made when you are starting a small business. One of the first ones is likely to be how to raise money, in order to finance your business operations. Keep in mind that you need to spend some time developing a business plan, no matter how you plan to obtain financing for your business.Then with business plan in hand you can then go forward with financing plans, for even a simple small business. One of the major ways that many people choose to finance their start up with is by using equity financing. However, it is important that you understand that advantages and disadvantages of equity financing.

Perhaps you have some cash you want to put into the business yourself, so that will be your initial base. Then maybe you also have family or friends who are interested in your business idea, and they would like to invest in your business. While this may sound good on the surface to you, (and even if this is the best arrangement for you), there are factors you must consider before you jump in. If you decide to accept investments from family and friends, you will be using the form of financing that is called equity financing.

The first thing that you must be clear about is whether your family and friends want to invest in your business, or loan you some money for your business. That is a crucial distinction and clearly two different things!If they want to invest, then they are offering you equity financing. If they want to loan you money for your business, then that is quite different and is actually falls under debt financing. There are several advantages to using equity financing-

  • You can start up your business without the burden of debt. Most new business owners like the fact that they can use their cash, and that of their investors, when starting up a 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 worrying about paying back loans.

  • You can explain (using your business plan) that the money from investors is at risk, and help them understand that if the business fails, the will not get their money back.

  • Depending on who your investors are, they may be able to offer valuable business assistance that you may not have. This can be especially important, in the early days of a new business. You may want to consider angel investors or venture capital funding, just be sure to choose your investors wisely!

  • Before choosing equity financing for your new business, it is also important to understand that there are disadvantages, as well.

  • You must accept the fact that your investors will actually own a piece of your business, and how large that piece is depends on how much money they invest. While you probably will not want to give up control of your business, you have to be aware of that when you agree to take on investors. Investors do expect a share of the profits.

  • You must act in the best interest of your investors as well your own. Since your investors own a piece of your business, if you fail to do this, you could open yourself up to a lawsuit. In addition, if you make your firm's securities available to just a few investors, you may not have to get into a lot of paperwork, but if you open yourself up to wide public trading, the paperwork may overwhelm you.

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