Equity financing

Ownership in exchange for money

BDC describes equity financing as companies raising capital by selling to investors, who receive an ownership stake. The funds do not have to be repaid, and if the business fails the investors are not owed their money back. That is the main contrast with debt financing, where a lender is owed principal and interest regardless of how the business performs.

The cost is different, not absent. Owners hold a smaller percentage afterwards, may share control, and the business shares part of its after-tax earnings with the new investors. The money raised appears in equity on the balance sheet, not as a liability, and does not count as income.

Who provides it and what must be decided

BDC lists family, friends, angel investors and venture capitalists as possible sources. Private small and medium-sized companies can find it hard to attract investors because shares in them are hard to sell. The business must settle the type of shares (common, preferred or voting), the price, who the buyers are and any dividend policy. Those choices are ordinarily set out in a written agreement and are best reviewed by a lawyer as well as your accountant.

An illustrative example

Suppose an owner holds all of a company’s shares and a friend invests $50,000 for a 20 percent stake. These figures are illustrative only. The company receives $50,000 of cash, which is recorded as share capital, not revenue and not a loan. No monthly repayment is due. The owner now holds 80 percent, and future profit or sale proceeds are shared accordingly. Had the same $50,000 been borrowed, the balance would have been recorded as debt and repaid with interest.

Many businesses combine the two. BDC notes equity financing is almost always balanced with some debt, which is generally cheaper and leaves owners with more control.

What to discuss with your accountant

Ask how the investment should be recorded, what changes in your ownership records, and how it affects owners’ equity and any ratios a lender will review. Confirm how the arrangement interacts with shareholder loans, in case an investor’s money is intended as a loan, not shares.

Also ask about tax consequences for both you and the investor before signing anything. They depend on the corporation’s facts and the structure chosen. For related ideas, see owner’s equity, long-term debt and the incorporation article.