Introduction
Students in recent times have opted to go entrepreneurial while still learning. Their biggest challenge however has been the source of finances as in most cases they want to start big businesses that would guarantee them higher profits due to economics of scale. However, faced with the problem of finances they have to start small and plan for growth depending on the performance of the initial business startup. Among the many who have gone entrepreneurial is one Rhonda Allegro. At the moment she has a very small fraction of the projected initial capital required to start her music store. She is looking forward to obtaining the rest of the money from equity capital as advised by SBDC. This paper thus engages us in a debate of the available sources analyzing how to fit or bad they are and checking out any available alternatives that could sort Rhonda out.
Sources of equity
Before we embark on discussing the common sources of equity, it’s good that we first understand why the term ”equity capital” and not just ”capital”. What Rhoda has at the moment is capital but not enough as such. The additional she is seeking is capital as well, only that it is sourced elsewhere. Having failed to get a loan for the remainder, equity capital has been recommended. Equity capital is different in that it is not a loan as such but a kind of loan given out not to be repaid back with interests rates. It happens that the lender will repay himself back by proportionately sharing out profits with Rhonda once the business gets started. Thus we can say that equity capital is funds traded for ownership shares. So the music store will pay out the loan instead of Rhonda doing so in case of obtaining a loan from a bank.
Obtaining equity capital for already successful operating businesses is not as hard as for new start-ups like in the case here. There are two primary sources of equity:
- Institutional investors
- Private investors
Institutional investors mainly consist of financial institutions such as investment banks, insurance companies, and depository organizations among others. The other type of investors is individuals who prefer funding start companies and share in the ownership rights instead of starting their own.
Both types of equity sources follow two modes of funding as equity funding and securities offerings.
Equity funding
These are generally investors who are basically interested in making their money grow by investing it in promising businesses. They, therefore, go out and seek the business starters in need of funding instead of the starters such as Rhonda going out to look for them. In such a case the capital ventures take the risk of investing their money in a business where investment returns are entirely dependent on the performance of the business. This mode is most preferred by large investors who target already established good performing businesses. However, this mode of financing is very expensive for small businesses though it’s applicable as the starter contributes a relatively small amount of the initial capital.
Securities offering
In this mode of financing the entrepreneur seeking financing has to produce securities in order to receive funding from the investors. The securities may be in terms of royalty financing contracts, preferred stock, and short-term mortgage loans. This mode of financing is not as expensive as the equity funding mode. It might be preferred by many start businesses due to its affordability but the fact that it requires securities which many of them do not have thus locks them out. It is advisable to enter into a contract with the financier for fulfilling the securities offering procedure for the business, for the firm’s safety. Such a contract cushions the owner of the business and the business itself from any violation of regulatory compliance.
Advantages of equity finance
- The funding is committed to your business and your intended projects.
- More management ability without interferences from investors
- Venture capitalists can bring valuable skills besides the money needed in the business
- In common with you, investors have a vested interest in the business’ success, i.e. its growth, profitability, and increase in value.
- Investors are more often than not prepared to provide follow-up funding in the future if the need arises.
- Disadvantages of equity funding
- Equity funds are demanding, costly and time-consuming as the entrepreneur has to provide background information about him and the business plan.
- Depending on the investor, you will be subject to varying degrees of influence over the management of your business and the making of major decisions that could compromise the initial startup plans.
- Your share in the business and control will be diluted. However, your share may be of a much larger business because of the funding.
- Equity funding calls for more legal technicalities that consume time and money (Sampson 2007).
Alternatives to equity funding
Having looked at equity funding as a source of capital and the realization that Rhoda has already failed to convince two banks to lend her the money then it appears that she has to have a broader basis of optional sources. But in mind, we have to admit the fact that being lent money as a student with little or no credit history is sometimes hard to come by. According to Bernstein (2007), the following are the major sources for funding businesses for college going entrepreneurs, personal savings, family and friends, student loans, and credit cards.
References
Bernstein, Peter (2007) Capital Ideas Evolving, 2nd Ed. New York: Wiley, pg 222, 269.
Lorna, Josh et al (2004), Venture Capital and Private Equity: A Casebook, New York: Wiley, pg 289-293.
Sampson, Guy (2007) Private equity as an asset, New York: Wiley, pg 118, 164.