Written by: Christopher Chitty
In our previous article, we wrote on how a company is able to acquire a loan through debt financing which is a less expensive venture if your company is successful but very expensive if it fails.
Equity financing works in the opposite way because it involves selling a portion of your company to shareholders in exchange for cash. If your company is successful, the costs incurred will be much higher. If it fails, it will be far less expensive.
As your company will not be indebted to banks and their interest rates and instead reliant upon private investors and venture capitalists, these investors will bear the brunt of the outcome. This is the main advantage of equity financing as the business is not required to repay the money. Investors will expect to reclaim their investment out of future profits and make more money which is the reason why such a venture will be more expensive if it succeeds.
Yet, capital is the weakness of most start-ups and as a result, debt financing may prove difficult to manage with the new business. Attempting to pay back loans with interest while struggling to churn a profit during the early stages of your start-up can be very daunting.
Equity financing removes this burden and provides start-ups with considerable funds to not only launch the business but mentorship and strategic guidance to help grow and make it viable.
Most private investors would take a hands-on approach with the business as they want to ensure that their investment does not fail. As they stand to make far more money than they invested should it succeed, it is within their best interests to make the business profitable.
Securing equity capital is not as tedious as taking up debt financing from the bank, but it does require the below pertinent information to be included;
Out of the above five points, it is especially crucial for the business to have strong growth potential. If your business shows no indication of it being competitive in your chosen industry, private investors may not be interested.
Cookie cutter start-ups are a dime a dozen but the creative and unique ones which brings something new to the market are sought after.
There are various ways you can acquire equity financing but venture capitalists and business angels are the two major advocates for this. Other sources include banks, investment companies and financial institutions. In order to find the right investor, you will need to determine where your business life cycle is first.
Once you have established just where you are, you may approach some of these private investors;
1. Angel Investors: These are wealthy individuals who prefer to invest in high risk ventures that are in the early stages for a share of the business. They invest their business skills and capital in start-ups. Angel investors can work independently or be part of an angel network which usually means the start-up gets a much larger capital. They will invest in start-ups that have high growth potential which belong to sectors they are at ease with. Start-up entrepreneurs can look to benefiting from their Angel investors' guidance and mentorship as they grow their business, although there are some which prefer to act as sleeping partners. If your business is in the early stage, Angel Investors are the best source for acquiring equity capital. In Singapore, Angel Investors are a driving force behind raising capital.
2. Venture Capitalists: These professional investors will want to play a very active role in your business, providing not only funding but advice and guidance on how to increase and improve the profitability of your business. As most venture capitalists in Singapore prefer start-ups that are at an advanced stage and are in high growth areas such as IT, biotechnology and nanotechnology, they expect a higher rate of return from the invested company; usually 25% and above.
3. Private funds: Banks, investment companies and financial institutions are sources of private funding. Do not expect anything more than financial investment however, as these establishments are content to leave the managing of the company to the entrepreneur and his team. Their only purpose is to receive an attractive return on their investment therefore such funding is suitable for business which have already been established, have high growth potential and are generating revenue.
The Singapore government intends to attract Angel Investments of up to $600 million by 2015 into the country. This will hopefully encourage more start-ups to choose Singapore as their base of operations as the money will be here.
However, it is not wise to rely completely on a single type of funding. Both debt and equity funding have their pros and cons and every entrepreneur should learn to use both when necessary. Hire professional accountants and lawyers to assist with all financial decisions.