What is Equity Financing?
Equity Financing refers to the raising of funds through the sale of shares of a business. It primarily refers to the exchange of an ownership interest in a business for an injection of capital.
Equity financing essentially consists of a myriad of activities that range from raising a few thousand dollars from familiar people, to massive initial public offerings (IPO) that could involve millions of dollars.
While most people have the idea that equity financing only involves large multi-national corporations, it can actually also include small medium enterprises or even startup companies.
Difference Between Equity Financing and Debt Financing
When on the topic of equity financing, one should also have a clear understanding that it is entirely different from debt financing, which mainly refers to money that is borrowed by a company, such as a business loan Singapore.
In such a set-up, it is generally the consensus that the parties who invest will be the ones who hold the most risk. For example, if a company of interest goes underwater, it is largely the invested parties who will suffer the loss of their investments. However, if the company of interest uses the funds wisely and succeeds in terms of growth and revenue, investors will usually find that the returns on their investments can be significantly higher than the returns that come from mere interest rates.
Ironically, when compared to debt financing, the cost of equity financing can seem high if a business actually succeeds, but may seem like nothing if a business fails, simply because a business owner would know that in the event of failure, he does not fall into debt. However, it is also good to bear in mind that the selling of company shares is often a one-way street, with little to no chance of turning back. The investor that you sold your company shares to will always be a part of your business.
Be absolutely selective of who you are giving up equity to. Be sure to pick your investors wisely because they will be a part of business for the long haul.
Here is an infographic on the pros and cons of equity financing in Singapore:
How Equity Financing Works
When a company grows and expands, there will always be a need for additional funds, which can be raised through either debt financing or equity financing. With equity financing, capital is raised by selling company shares to investors. There are no repayment schedules to adhere to, and there is a good chance of coming into partnership with powerful and influential investors.
To begin the process, a valuation of your company is done to set an estimate of what your company is worth at that point in time. The amount of shares to be sold will then be determined by the amount of capital that investors are willing to inject into your business, and/or the amount that you are willing to take in.
As equity owners of your company, your investors will always be rooting for your business to be successful. If you are able to use the additional funds to grow and expand your business effectively, your investors will also have a share in the growth of your company value and profits.
Types of Equity Financing
Of the many challenges that come with the journey of running a start-up, many entrepreneurs would agree that cash flow and capital acquisition are some of the main struggles that they have encountered with. Most startups are initiated with limited personal savings, or capital raised from close friends and family. Sadly, this initial source of funds often runs dry, which then leaves many startup entrepreneurs in a dilemma.
However, among the various avenues of financing, equity financing should always be kept as a viable option. Equity financing in essence, revolves around private investors who are seeking capital gains through investments in start up businesses. More often than not, many investors who invest in startup businesses simply love the thrill and excitement of being able to witness and be a part of a young company’s growth from seed stage to a successful functional business. For the lack of proper assets or the ability to get a business loan, equity financing can actually serve as a great alternative source of startup financing.
Now, given the understanding that the equity funding culture in Singapore may not yet be fully matured, you should expect that unless you are able to present a business plan that is substantial and outstanding, it may be a tall challenge to obtain any equity funding. For a start, you should be able to present an innovative yet rational business plan, that includes a clear exit strategy, realistic cash flow and revenue projections, a meticulous cost structure break down, and a brilliant action plan to make profits.
Corporate angel investors and venture capitalists make up the bulk of equity financing in Singapore. Other potential investors include hedge funds, private equity funds, investment banks and a few private alternative financiers:
1. Angel Investors
Usually high net worth individuals who have deep pockets of cash, are risk-seeking and enjoy the thrill of investing in startups with the hope of gaining potential exponential returns. In other words, angel investors are usually private investors who prefer to utilize their financial resources and business skills in startup businesses.
Angel investors usually act alone, or sometimes, they form a network of fellow angel investors and act together as a group. These angel investors tend to offer investments to startups that they believe to possess exponential or infinite growth potential.
Angel investors also have a tendency to invest in businesses that they are somewhat familiar with. Some angel investors also like to actively participate in the startup by offering themselves as consultants or advisers who provide advice, direction, or even resources to the business owners, while others remain in the back seat as silent investors.
2. Venture Capitalists
Mainly consists of seasoned professional investors who set up venture capital companies for the purpose of investing in young companies, while also participating in the operations of the business, albeit from a more macro perspective.
As with most angel investors, venture capitalists do not stop at investing into a company, they also get involved in the operations and directions of the company, in hopes of helping the company to make more profits. However, this can sometimes come across to the business founders as overbearing and domineering. In most cases, venture capitalists usually demand for a bigger stake of up to 25 percent or more of the company that they are investing in.
In Singapore these days, there is a trend that is clearly showing venture capitalists with increased preferences for investing in startups or young companies that deal in the areas of intelligent programming and advanced technology.
3. Private Equity Funds
Usually big private equity firms with very large bank accounts and very deep pockets. In Singapore, the main providers of private equity funding are usually financial institutions, investment firms, hedge funds, or private equity fund houses.
Unlike the angel investors and venture capitalists, these big private fund managers usually do not bother to participate in the startup businesses that they have invested in. Their only concerns mainly revolve around how much profit their investments can make. Normally, funding from these private equity funds go to the bigger businesses that are already established and generating consistent revenues.