If your small business needs capital and you don’t have enough cash on hand, a means of getting that capital is through equity financing. Equity financing is outside financing that can come from a variety of sources, including professional investors (venture capitalists) as well as ordinary citizens such as friends, family members and employees.

Equity financing gives partial ownership of your business to the investor. Think of stock purchases that you may have made to get an idea of how this works. If you purchase 100 shares of a company that has issued 10,000 shares, you now own 1 percent of that company. Similarly, an outside investor (for example, a venture capitalist) will own a percentage of your company if you accept his or her funding.  For more on equity financing, click here and here.

What are the pros and cons of using equity financing?

Pros

Get Money More Quickly
Whether you are just starting out or need capital for another purpose, you can get the money you are looking for a lot quicker by having outside investors. You won’t have to save up as much money on your own for your business needs.

Less Risk
With equity financing, you are using someone else’s money. This money represents their investment in the company. Again, think of this in terms of a stock purchase that you may make: if you purchase $1,000 worth of shares of XYZ company and they go out of business next week, you will lose your entire investment and they won’t have to pay you back, as your investment represented your stake in the company, not a loan. This is essentially how equity financing will work for your business.

So, if your business tanks and you jump ship, you will lose less of your own money than if you funded it all on your own. Also, you won’t be indebted to your investors, although they may be quite angry!

Cons

Reduced Control
Every bit of equity financing that is given by an outside investor represents a stake in your business for that person. The more equity financing that you accept, the more control other people will have over your business. Think about this from the investor’s perspective: If you invested enough to own 20 percent of a business, wouldn’t you keep a close eye on what was going on and want to be in on the big decisions?

Be sure that you are comfortable with others having a say in your business operations before accepting equity financing, as most investors will want to have some control of your company after providing financing.

Sharing Profits
As mentioned, your investors will own a share of your company. As a result, they will share in the company’s profits.

The Bottom Line
Equity financing can be a great source of capital for your business. However, be sure that you are comfortable with the pros and cons of doing so before pursuing this option.