Tips for Equity Financing: Sharing a Piece of the Pie for Immediate Cash

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Each has pros and cons
Banks loans provide funding without requiring financial payback beyond the amount of the loan, plus specified interest. Most importantly, bank loans do not require giving up a percentage of ownership, revenue or profits. Bank loans may require tons of paperwork, but once a loan has been secured from a lending institution, future funding usually requires much less paperwork.

Lines of credit provide an excellent way to receive ongoing funding without borrowing more than needed at any given moment and you essentially eliminate paperwork for future borrowing. When a small company has adequate credit and collateral, bank loans are the method of choice for raising cash, especially when interest rates are relatively low.

Tapping personal savings is an age-old way to fund a company's start-up or growth. You have no one to ask, little or no paperwork to do (with the exception of agreements between owners) and often no time schedule for payback. The greatest risk is that the money will not be put back into your savings.

It's always tempting and possible, after all, to use profits for additional business needs without paying yourself back. This can result in reduced retirement funding and family distress.

Equity financing can serve as a powerful tool for small-business growth when used for the right reasons. When a company does not have an adequate record of accomplishment or the collateral required for a bank loan, and if the owners do not have enough personal savings, equity financing may be the only option when cash is needed though a percentage of the ownership and profits is given up.

Even when a bank or personal loan from savings could be secured, equity financing makes sense when the individual or group giving the funding has expertise that could benefit the company.

Ideally, equity financing is used not only to secure cash, but also to make key individuals committed to the company's success. For example, a small-business owner may be an expert in manufacturing the company's products, but lack experience in marketing.

By securing a bank loan, funding is obtained, but the lack in marketing expertise remains. When equity funding can be received from an individual experienced in marketing and who will take part in the company's day-to-day marketing activities not only do you raise additional cash, you strengthen the company as a whole.

The same holds true in the case of equity funding by a group.
Often, venture capitalists or other types of lending organizations have experienced personnel who can contribute enormously to a small company's success. Once money is invested into the company, the group has strong incentive to do everything it can to assure its success.

The owner of a small company must always compare the financial advantages of equity funding to what is given up in ownership and control. A hands-on type of owner may become discouraged by loss of autonomy, if a significant percentage of the company is given up, and the equity partner begins to exert control.

Stories abound of owners who have been ousted from their own companies by equity partners who gather shares or voting rights from smaller minority owners (even from family members and close friends of the owner). Be aware of this possibility when committing to giving up a percentage of the company for equity funding.

Equity funding is a complex transaction that can become more complex after the deal is done. Consult with your attorney, business advisers and accountants to consider all aspects and ramifications in both the short and long term.