INTRODUCTION
Equity financing entails the sale of stock in exchange for cash. Company ABC’s owner, for example, may require additional funding to support the company’s future growth. The company’s owner decides to sell a tenth of the company to an investor in exchange for capital. This investor now has a ten percent stake in the corporation and can influence future business decisions. With equity finance, you don’t have to repay the money you borrowed. A company’s owners naturally want it to be successful and give the equity investors a high return on their investment, but without having to make payments or pay interest, as with debt financing.[1]
The corporation is not burdened by new financial obligations as a result of the equity financing. Because equity financing does not demand regular monthly payments, the corporation has more money to devote to expanding the business. However, this does not mean that equity financing is without risk. The drawbacks are substantial. You’ll have to give the investor a piece of your company if you want to get finance. To make decisions that influence the company, you will have to consult and split earnings with your new partners. There is only one way to get rid of investors, and it will cost you a lot more than you received in the first place.
ADVANTAGES OF EQUITY FINANCING
- A different means of financing:
In general, equity financing has the advantage of allowing enterprises to avoid going into debt. Those startups that aren’t eligible for significant bank loans can raise money from angel investors, venture capitalists, or crowdsourcing platforms to finance their operating expenses. Because the company does not have to repay its shareholders, equity financing is seen as less risky than debt financing in this situation. Investors are generally long-term oriented and do not look for a quick return on their investment. Rather than focusing on debt repayment and interest, the corporation is able to reinvest the cash flow from operations to grow the business.
- Having a network of business associates and financial resources at one’s disposal
Company management might benefit from equity funding as well. Some investors want a hand in the company’s operations because they want to see it succeed. Success in the business world gives them access to key resources including business connections, management knowledge, as well as access to other sources of finance. Many angel investors and venture capitalists help businesses by investing in them and giving them financial support in the form of investments. It’s critical for a company’s early stages.
DISADVANTAGES OF EQUITY FINANCING
- Dilution of control over ownership and operations:
The biggest drawback of equity financing is that it requires business owners to part with some of their equity and so dilutes their control over the organization. Any future profits made by the company, regardless of profitability, must be distributed as dividends to shareholders. The equity stake requested by many venture funders is between 30 and 50 percent, especially for firms without a solid financial foundation. Many business owners and founders do not want to give up so much of their corporate control, therefore their options for equity financing are limited.
- Tax shelters are absent:
Equity investments aren’t tax-sheltered compared to debt investments. Dividends paid to shareholders are not tax deductible, although interest payments are. Dividends paid to shareholders are not deductible. As a result, equity financing will be more expensive. Long-term, equity financing is thought to be more expensive than borrowing. Due to the fact that investors want a bigger return on their investments than banks do. As a result of the higher risk, investors demand a higher return when they fund a company.
PROMOTION OF DEALS VIA EQUITY FINANCING IN THE EUROPEAN MARKET
One of the main goals of EU financial regulation, as well as the capital markets unification agenda of the European Commission, is to make it easier for European enterprises to get external equity financing. Due to Europe’s corporations’ high levels of debt and reliance on bank financing, a focus on equity is necessary to avoid a financial crisis. Equity investors also help investee companies implement operational and governance reforms that boost productivity.
The amount of listed equity in EU non-financial corporations’ overall balance sheets has increased, however this is only true for major firms in the core euro area. While net capital from the issuing of listed equity has decreased, private equity has swiftly expanded and is already back to pre-crisis levels. This is good news for small businesses because private equity is more accessible than public equity.[2] According to data at the company level, external equity is still a rare occurrence. Since the tightening of credit terms in the early aftermath of the financial crisis, the share of companies using external equity has decreased. The perceived gap between needs and available equity funding has not reduced despite improving overall financing circumstances.
In Europe, the equity market in the United Kingdom is the most advanced; other EU countries are significantly less attractive to private equity investors, and there have been no changes in important policy areas. There is a reluctance to dilute control held by established owners due to corporate governance practices such as minority shareholder rights. There is still a considerable domestic tilt in EU private equity activities. Private equity firms’ fundraising and eventual divestment outside of national capital markets have become incrementally more important, but overall remain very limited. Local capital markets continue to constrain smaller countries, and government agencies play a significant role in funding.[3]
This regulation reflects post-crisis financial stability fears that are not supported by the business model of the industry. The fragmentation of supervision makes international fund transfers even more difficult. Nearly half of Europe’s investor base is based in the UK, thus the country’s departure from the single market poses a severe danger to EU equity investment. The EU should examine increased risk tolerance and harmonized capital requirements as part of future capital markets union legislation.[4]
CONCLUSION
Investing in start-ups and small firms that have the potential for long-term growth is known as venture capital, which is a subset of private equity. Well-off individuals, investment banks, and other financial institutions are the most common sources of venture capital. It can, however, be offered in the form of technical or management skills as well as money. Small businesses with outstanding development potential, or those that have developed rapidly and are positioned to do so in the future, frequently receive venture funding.[5]
In conclusion, this type of funding is used to fund fresh concepts that are riskier but also have the potential for greater growth and profit. Long-term equity investments in high-risk enterprises with high reward potential constitute venture capital, according to this definition. SEBI (Securities and Exchange Board of India) rules control venture capital fund operations in the country. As a firm or a trust, venture capital funds can raise money by issuing securities or units or by loaning it to other companies. This is allowed by the SEBI law.[6]
Author’s Name: Vishakha Bhandakkar (New Law College, Bharati Vidyapeeth University, Pune)
[1] J.B. Maverick, ‘Benefits Company Using Equity Financing v. Debt Financing’, (2021) Investopedia, accessible at: <https://www.investopedia.com/ask/answers/042215/what-are-benefits-company-using-equity-financing-vs-debt-financing.asp> last accessed on October 15, 2021.
[2] Ines Goncalves Raposo & Alexander Lehmann ‘Equity and Capital Market Integration in Europe’, (2019) Bruegel January 17, 2019, accessible at: <https://www.bruegel.org/2019/01/equity-finance-and-capital-market-integration-in-europe/> last accessed on October 15, 2021.
[3] Ibid.
[4] Abhilash Mudaliar, Hannah Schiff, and Rachel Bass, ‘Annual Impact Investor Survey 2016’ (2016) 44 New York: The Ginn, available at: <https://thegiin.org/research/publication/annualsurvey2016.> last accessed on 15 October 2021.
[5] Ibid.
[6] Bank for international settlements, ‘Establishing Viable Markets’, (2017) CGFS Papers, accessible at: <https://www.bis.org/publ/cgfs62.pdf> last accessed on October 16, 2021.
