What Does an Equity Loan Mean in Business?

Starting or expanding a business requires a lot of effort and funds. It is often recommended that new or expanding businesses must refrain from utilising their personal funds for business purposes. So, most businesses turn to either debt financing or equity finance loans to meet their financial needs. Today, in this article, we will look at equity loans and how they can help your business in detail.
 

What is an Equity Loan?

Equity loans, also known as equity financing or equity funding, is a source of finance for businesses in which an entrepreneur exchanges a percentage of their company ownership in return for a certain amount of money. To understand the equity loans meaning in a better way, let's use an example. 
 
Assume you run an XYZ company and require Rs 10 lakh in cash. Mr A, one of the firm owners, appreciates your business plan and is willing to give you the necessary finances in exchange for a 30% equity stake. If you agree to this offer, then Mr A will become a partial owner of the company. 
 

How Does Equity Finance Loan Work? 

It is difficult to obtain a loan from a financial institution for businesses that are not operating well owing to funding limits or for a start-up business that does not have business assets or is financially established. In such a scenario, they turn to equity loans. Equity funding can be obtained from a variety of sources including friends, the general public, venture capitalists, and large business owners.
 
The steps of closing a deal for equity finance loans differ from one investor to the next. In the case of public or private companies that are raising funds from the public through IPO, the process is complex and is regulated by a concerned regulatory body. Under this type of financing arrangement, you are not required to pay EMI or interest rate.
 
However, when your business makes a profit, you need to distribute the portion of it to the investors and may also declare dividends.
 

Advantages of Equity Financing

 

• Low Risk 

  In the context of a borrower, a loan against equity is less risky. This is because, under this arrangement, investors are given shares and stakes in addition to a set percentage of ownership. As a result, even if the business fails and you lose all of the stakeholders' money, there are no repayment obligations. Remember that equity is highlighted in the asset column, not the liability column.
   

• Resolves Cash Flow Issues

  Under this source of finance for business, investors do not take away your company's funds. You are neither required to repay monthly instalments for such funding nor are you liable to pay interest. As a result, equity loans are known for boosting a company's cash inflows.
   

• Network Building

  Equity loans imply the onboarding of powerful investors who are directly or indirectly involved in business operations. Investors assist firms in providing strong business networks so that the company's growth and expansion can double their investment. These investors can also help you grow by providing mentorship and sharing their vintage experience if you are a start-up.
   

Also Read: Financial Tips to Set Up a New Business 
 

Disadvantages of Equity Finance Loans

 

• Sharing of Ownership 

  When you raise funds through an equity loan, you allot some share or stake to the investor. The number of shares or the percentage of stake reflects investors' ownership. As such, if a single investor provides significant funding, there may be a conflict of interest because ownership is distributed proportionally among several individuals.
   

• Increased Accountability 

  When you have investors on board, you must keep them up to date on all business decisions. Investors require regular and accurate reporting on the performance of their vested funds. They also require regular insights into the activities of the organisation. However, this is not the case when it comes to borrowing from financial institutions. Lenders are primarily interested in whether or not you pay on time.
   

• Profit Sharing 

  When your company makes a profit, you must distribute it to the investors in proportion to their stake in the company. You must also pay the stockholders a dividend over time.
   

• Investors' Opinion Matters 

  When you raise funds from investors, they are directly or indirectly involved in your company matters. In most companies, the big investors/ shareholders are given a seat on the board of directors. Any decision that was to be executed in the corporation had to be approved by the board of directors. As a result, every shareholder who disagrees with your viewpoint has the right to vote against you.