Practically, every start-up entrepreneur faces the problem of choosing the right financing option to fund his new business venture. Generally, entrepreneurs choose between debt and equity financing as standard means of business finance. Borrowing money straightaway from lending institutions with a formal agreement between the lender and borrower is known as debt financing. Loans of this kind have to be repaid along with a sizeable amount of interest applied on them.
Unnecessary amount of debt may increase the direct financial liabilities of entrepreneurs. This can make debt payments with both the principal and the interest, a tough job. There are stringent penalties for business loan defaulters. These problems may force emerging entrepreneurs to look for debt relief options to save themselves from drowning into a sea of debt and the business.
Therefore, entrepreneurs can choose equity financing as a safer alternative to fund their start up venture. Basically, it is a financial approach in which a part of the business is sold off to investors in return for capital, meant to be used for business purpose. Moreover, start-up entrepreneurs do not have to service any debt to run the business. These investors are also known as equity investors who emerge as business partners and have considerable amount of say over the policy making decisions related to the business.
Equity financing (Share Capital) – Its procedures
Start-up entrepreneurs may opt for either of the 2 ways to get equity financing for their businesses. These are – first, private placement (sale of stocks to private investors and/or venture capitalist) and second, initial public offering or IPO.
Private Placement: Private placement is one of the foremost financing options for budding entrepreneurs. It follows a simple processing format. Companies offering private placement of stocks are required to follow the federal and state securities laws. Moreover, it is not necessary for them to be formally registered with the Securities and Exchange Commission.
Companies raising money through ‘private placement’ cannot publicize their offers in the open market. Apart from that, they should do all the transactions within closed doors, i.e., face-to-face with the buyers. Basically, private placements involve some chosen investors and corporations. In most cases, there is no compulsion to provide elaborate details of the offer. On top of that, offer manual or prospectus is also not given to the buyers.
Initial Public Offering: Start-up ventures, who want to raise money from the capital markets through IPO, are required to go through a long and exhaustive registration process. The cost of IPO is approximately 20% of the raised money. This is why it is better for the established organizations rather than start up businesses, to raise capital through IPO.
IPO has an edge over private placement. This is because the actual business owner can have far more control over the business by distributing the rights to large groups of investors. This does not happen in the case of private placements where the owners or partners belong to a particular venture capital firm.
Equity financiers – The financing source
Equity financiers come from diverse sections of the society. They can be private investors, better known as ‘angels’. Private medical practitioners, local businessmen, rich entrepreneurs and so on can be angels. Moreover, insurance corporations, large companies, investment bankers, venture capitalists, government undertaking firms like Small Business Investment Corporations or SBICs, working professionals (for example, Employee Stock Ownership Plan or ESOP), unemployed people, etc. are some of the sources of equity financing.
Start-up entrepreneurs should have a compelling business idea in order to convince equity financiers to invest their money into the business. In addition to that, they must create a business plan with all the financial forecast included in it. Therefore, with all the proper care and planning, start-up entrepreneurs can raise capital to fund their business without incurring any debt at all.