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May 24, 2011

The Advantages And Disadvantages Of Raising Equity Funding

When you’re trying to raise capital, the first and most important decision you’ll need to make is whether you should use equity or debt financing. Venture capital is equity financing, which significantly differs from loans from banks and other financial institutions, which fall into the category of debt financing.

The biggest downside of seeking equity financing is that you first need to qualify. Venture capital firms prefer companies which show rapid growth and a good chance of going public or being acquired by a larger firm within the space of a few years. In order to have a shot at receiving equity funding, you need to demonstrate that your business occupies a fast growing sector and that you are able to command a sufficiently large share of the market to grow quickly and give investors a healthy return.

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It takes a lot of work to raise venture capital. You’ll have to put together a compelling business plan, prepare financial projections and presentations and likely bring in outside help to make your proposal one which gets the attention of potential investors. Once you have these, you will have to identify and contact venture capitalists who are a good fit for your business.

One thing to keep in mind about equity capital is that you’re handing over a stake in your business in exchange for funding. The upshot of this is that if your company is acquired or goes public, you’ll be sharing those proceeds with the venture capital firm in proportion to their investment.

However, it’s usually better to own a smaller share of a larger company than to own a larger share of a smaller company. For instance, a 20% share of a $10 million company is worth much more than 80% of a $1 million company.

Venture capitalists usually focus on a single industry and once they invest in your company, you will have access to their resources; they generally have partners with in depth knowledge of your industry which can be of great assistance. Most venture capital firms will also want a seat or seats on your Board of Directors, though this can actually be a good thing for your company; remember, your investors have the same goal as you do – for your company to be successful.

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Venture capital firms have deep pockets and if your company shows promise of continued growth, it is more than likely they’ll be able to provide additional funding as needed. They can also put their resources to work for you to help your company to grow and thrive in the first place.

Perhaps the biggest advantage of raising equity funding from venture capitalists is that you can focus your efforts where they are most needed, on growing your company. Unlike debt capital, you don’t need to worry about payments or interest. If your company is still in the early stages of its development and focused on growth, equity funding can be exactly what your company needs to begin turning a profit.

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