How to Borrow Money, Part 1: Equity Financing

There are two types of financing: equity financing and debt financing.

The most frequent source of funding for a small and mid size businesses is to borrow money. Getting a loan usually is not an easy and short process.

It is always a good idea to learn as much as you can in advance about the factors that important in the decision-making process of banks and other lenders when they consider your loan application. For more detailed information you may refer to my other articles.

When looking for funding, you should consider your company's debt-to-equity ratio, which is defined by dividing amount of borrowed money by amount of invested in the business. The lower the ratio is: more invested and less money borrowed, the easier for you will be to get financing and at more favorable terms.

The decision what financing to pursue works on case to case basis, but the general rule of tomb is: if you have a high debt to equity ratio you should seek equity financing and vice versa.

In the most cases it is impossible to get 100% financing. Institutions want to see at least 20% of equity in a business. Building equity can be achieved by investing owners’ cash or build it through retained earnings, but by itself does not guarantee that you get financing for a business.

Equity Financing

Equity financing means financing a business by selling ownership interests to investors or, the money is raised in exchange for a share of ownership in the business or having the right to convert other financial instruments into stock. It is the way raise funds without incurring debt, or without obligation to repay a specific amount of money at a particular time.

Equity sources can be divided into two groups: non-professional such us relatives, friends, and employees, etc. and professional that can be divided into two sub groups: Private such as Angels and Venture Capital and Institutional such as Hedge Funds and Government Assessed Sources. Most of professional groups specialize in particular industries.

Venture Capitalists may review thousands of proposals a year, but invest only in a few that have bigger prospective returns on the capital, great management team, industry growth, competitive advantage and solid exit strategies (e. g. IPO). Venture Capital firms usually passively involved in a company’s management, unless business fails to perform as projected.

Many people think that Venture Capital firms finance new businesses, but in the most cases they prefer established companies with stable cash flow. If you need money for a start up look for an Angel (Private) Investors. Angels might work alone or in groups (sometimes as big as few hundred people) and usually actively involved in company’s management.

Pros and cons of equity financing:

Company shares give you two major rights: participation in the future company’s profit-sharing and decision-making processes. The biggest drawback of equity financing is that you relinquish those rights to an outsider.