A new business can be funded through owner’s funds also called equity or share capital. In funding through equity respective contributors to the fund gets part ownership of the business usual proportion to their funding. Because bigger contributors bear greater risk, they also have greater voting power in the governance of the company. Businesses of any size can be funded through selling of shares. However, in South Africa this option is more formal and more common amongst large corporates.
For a small business, shares are often sold privately amongst a few business associates, friends, family and other individuals and entities within the entrepreneurs social circle. As firm grow bigger investment banking arms organize private placements for unlisted shares. When additional but large capital investments are required, a company can list of the stock exchange and trade its shares publicly. This and the whole equity issuing matter has got its advantages as well as disadvantages. These are explored below:
Advantages of equity funded business:
- Equity funding does not result in interest and loan principal repayments that are often a burden when turnover is low.
- Equity ameliorates the need for collateral which is also another major challenges for small firms .
- The payment of dividends or part profits to shareholders is directly tied to profit hence a business is not obliged to pay.
- Equity markets are fairly wider than debt markets. There are a number of registered lenders but almost an unlimited number of potential share buyers
- Failre to pay dividends as a return to shareholders does not result in liquidation of the business.
- Equity holders are more likely to pump in additional capital in cases of business underperformance due to capital constraints. Lenders are not.
Disadvantages of funding a business through equity:
- Sell of shares reduce the degree of control the entrepreneur has as co-shareholders do have a say in how the business is managed.
- Equity often results in double taxation as a company’s gross profit is taxed and the individual dividends per shareholder is also taxed.
- Equity funding is not as flexible as debt financing when it comes to shorter funding periods and smaller amounts
- Formalities are usually long and costly for more formal equity sell arrangements
The final decision to sell shares or to resort to debt as a mode of finance rests with the entrepreneurs preferences, in consideration to the above-stated merits and demerits. For a small business, your business plan becomes the most important document in determining the value of the proposed business as well as the share prices. It is therefore very important to thoroughly do you research.
The following tips are given to small businesses:
- Preferably sell shares to individuals with whom you have a common understanding, possibly someone within your social circle. Personality differences are a major cause of disharmony amongst shareholders.
- Ensure that proper procedures are duly followed including inclusion of new shareholders on company structures and registration documents. Always issue share certificates and amend your memorandum and articles of association to formalise the arrangements if necessary.
- Always seek professional assistance from business consultant and attorneys.