Every business needs sources of funding for a variety of reasons. Common areas of need are for acquiring capital assets, new machinery, and building construction to name a few. Product development can be another costly venture which would require added funds.
Usually, such needs are funded internally, while capital for buying machines may come from outside sources.
In this age of tight liquidity, many firms have to look for short-term capital to provide a cash flow cushion.
Stock financing or equity financing is the process of raising funds through the sale of shares in a business and can have its own benefits compared to the traditional sources like banks.
Your company sources funds from an investor who agrees to share your profit and loss without expecting any fixed returns. They become owners of the company to the extent of their share of investment.
Advantages of stock finance
- The raising of funds is focused on your business and your intended projects. Investors get returns on their investment once your business is doing well.
- There are no costs of servicing bank loans or debt finance which frees you up to use the capital for business activities
- Investors expect your business to give returns which makes you explore and execute more growth ideas
- Business angels and venture capitalists can bring skills, experience, and contacts to your business. They can also give inputs on strategy and help in key decision making.
- Investors are prepared to provide more funding as your business grows because they now have a vested interest n your business and they will support any venture that will make your company flourish.
- It can be a permanent solution to the financial needs of your company.
- Provides leverage to management and helps them focus on achieving core objectives. They don’t worry about having to raise capital over and over as the need arises.
- You have no obligation to pay dividends or choose to pay smaller dividends based on your cash flow position.
- You have a controlled financial leverage ratio which is the ratio of financing to equity and debt. A bank requires a company to invest around 20% to 25% of equity to finance the balance of 75% to 80% debt.
- The company can retain the earnings you generate from the shares and use additional working capital. It can be used to fund other projects or infused into working capital.
Disadvantages Of Stock Finance
- Raising stock finance is costly, demanding and time-consuming and may take the focus away from core business activities
- Investors will look for comprehensive background checks on you and your business. They will check on past performance and forecasts and will probe your management team.
- There is a chance that you may lose a certain amount of power in management decisions. Dilution of control is the result when new shareholders are introduced. Debt financing does not have this dilution.
- You need to invest time to provide constant information for your investor to monitor
- At the start, you will have a smaller share in the business in percentage and monetary terms. Your reduced share may be worth a lot more in the long term as the business earns more profit
- There may be legal and regulatory rules to abide by when raising finance and promoting investments. Other costs may include a fee of a merchant banker, brokerage, underwriting fee, and other expenses.
- The dividends you give to shareholders are not a tax-deductible expense. You don’t get a tax shield compared to interest expense on your loans.
- Equity share is a high-risk form of investment so you can expect investors to look forward to a higher rate of returns.
- If you offer stocks to the public, you are required to appoint underwriters. They assume the risk of subscription and agree to subscribe the shares to the extent of shares not being subscribed to by the public and charge you a fee for that service. It can be in the form of payment or discounted equity share price.