What are Equity Investments?
Equity Investments is the money put into a company for its shares, both privately and in the stock market, is equity investment.
Small business finance includes equity financing and debt financing. Both these types of financing, ie. with loans from the bank and company funding from investors, create a balance between sharing the profit of the company and incurring interest from company loans. However, it is normal to see companies take up more equity investment than debt investments over the course of the business.
The money put into a company for its shares, both privately and in the stock market, is equity investment. Typically, these shares are traded in the stock exchange. Investors buy shares of a company believing that they will earn dividends on the shares or that its stock price will appreciate. If the equity investment value rises, the shareholder can sell for a profit. By adding diversification, equities can help strengthen the portfolio asset allocation in a company.
Benefits of equity financing investments
There are many benefits of equity financing investments, some of which are:
- By investing in equities you can achieve your financial goals if you hold it long-term.
- Risk diversification: In mutual funds, liquid funds are low risk, whereas equity funding carries a much higher risk level. Diversified equity mutual funds hold the script of 35-40 individual companies, therefore giving you diversification when you invest in equity. For example, IDFC Focused Equity Funding invests in a maximum of 30 stocks, which is an open-minded equity scheme.
- Possibility for inflation-beating returns in the long run: When you invest in equity, you are automatically qualified for the opportunity of gaining capital appreciation long term, but this also comes with some risk. But as an investor, you know that every investment on assets comes with some type of risk. Despite the fact that past performance does not ensure future returns, as the years pass, equity as an asset has good returns. Keeping this in mind that only investing in equity is not enough of a guarantee, you should remain calm and continue to review the portfolio in the long run.
- Dividend Income: Dividends are offered in certain mutual fund schemes. Even though the number of dividends is not certain and is liable to the availability of distributable surplus, it helps investors with intermittent and additional cash flows. But investors should take note that after dividends are paid out, the net asset value of dividend options depend on the extent of taxes and payouts.
- Higher liquidity: A majority of the investments in mutual funds are liquid. You can redeem the funds in 2-3 working days when the need arises. Also as the equity is held in units, you can redeem part of the equity depending on the amount you need. There is generally no exit cost if the shares are sold after one year. Based on the net asset value, you can easily sell them online, with the funds transferred to your bank account.
- Less Cap Requirement: Equity investments do not require you to have a lot of money to invest, unlike other assets, like fixed deposits, real estate, and gold. You can invest with what you have. This low threshold permits investors from different backgrounds to invest in equity. Equity investment can also help you generate enough money to build a stable retirement plan.
Risks of equity financing investments
Just like any other asset, there are numerous risks to equity investment as well. Direct impacts on equity investment are market risk, depending on the market forces, which will affect if the stock value will rise or fall. This can cause an investor to lose part or all of their investment. Other risks that can affect equity investment are:
- Inflation risk: Due to rising inflation, a company’s value could drop drastically
- Political risk: If there is instability or major political changes in a country, it could have a drastic impact on the value of a company.
- Economic concentration: The value of a company can drop due to it being too concentrated in one sector or factor of the market. This could lead to the company being affected the worst if any changes are made in the sector (for example, trends in the clothing industry).
- Credit risk: A firm unable to repay its debt.
- Liquidity risk: A company might be unable to fulfill its short-term debt obligations.
- Foreign currency: The value of a company can change due to fluctuations in the value of foreign currency.
Types of Equity Financing in Business
There are different types of equity financing investment methods that a business can have. These include
#1 IPO or Initial Public Offering
When a company decides to go public and sell its shares for the first time on the stock market, an IPO takes place. The shares can be publicly traded in markets like the NYSE (New York Stock Exchange). The term used to describe the transition from private to the open market is “going public”.
In compliance with the SEC (Securities Exchange Commission), this type of funding is developed adhering to its guidelines. According to the SEC, the IPO needs to be registered and approved. If it is a listing date given to the company by the SEC, the “listing date” is the date at which the shares of the company are going to be available for public trading on the market.
#2 Angel investment
Investors that provide financing to startups are known as angel investors. They are people with a lot of funding who are looking to gain high returns on the investments they make. They are very specific and accurate about the business they invest in.
There are investors that look for companies at the early stage, and provide them with the operational and technical knowledge to run and grow the ventures. They also provide funding for growth after the initial investment to start the company.
#3 Venture capital
Firms that provide you funding in return for shares or ownership of your business are venture capital firms. When these firms invest their money in start-ups businesses, they are looking for the highest return on that investment. They have a list of competitive businesses to choose from.
Venture capital firms, unlike angel investors, do not use their personal funds to invest. These firms, which can be a group of high worth individuals, gather their money together to invest in growing companies or start-ups. These firms may also ask for a seat at the BOD.
This is because some of them see this as a way of managing or assisting the investment. Many of these firms have taken a mentoring approach to help companies with their investment growth.
#4 Equity crowdfunding
Equity crowdfunding is a way of selling the shares of your company before the product hits the market. They can invest in your company in the early stages even if it is not listed in the stock market. The owners of startups or privately held businesses raise money this way by selling parts of the company or equity ownership.
#5 Royalty financing
Equity investment in the future sale of a product is revenue-based financing or royalty financing. The difference between royalty financing, angel investors, and venture capitalists is that you have to make sales before the approval. Investors expect to receive returns immediately because of the consensus made with the lender. Royal financers give cash upfront to businesses to cover their expenses in return for a percentage of the product’s revenue.
Equity Investment or Debt Investment – which is better?
Lets define each type of investment before we decide which one is more suitable for your company.
What is an equity investment?
When an equity investment is made in a business, you are buying a stake in the firm. In exchange for a certain percent in the profits, equity investors provide capital, mostly in the form of cash. The business uses this capital for numerous things such as cash for daily operations, hiring new employees, reducing debt, or for capital expenditure needed for the expansion of the business.
In certain cases, the amount you invest can be proportionate to the percentage of stake you get in the business. For example, if you invest $60,000 in a business and an investor puts $40,000 he only gets 40% of the stake in the business. This is because his contribution was 40% in the business giving him 4/10th of the equity. In other cases, the dividends and ownership percentage can be different.
What is a debt investment?
When a debt investment is made, you are loaning the company money in exchange for interest along with the repayment of the principal amount. Debt capital is provided in two common ways, which are direct loans with normal amortization (reduction of the interest then followed by the principal amount), or by the purchase of bonds that are issued by the company.
Which is the Better One?
Just like many things in life, things are not always black and white. If you invest in equity in a business that does well, you can increase your investment and potential profits. Similarly if you bought bonds of the same company, you would have a good return on the investment you made over the years.
But on the flip side, if you buy into a business that fails, then you lose your investment. In this scenario, the best chance for you is if you own debt in the business, not equity. Equity in a company that is debt-free can not have a greater risk than the debt investment in the same company, this is because in both cases you will be ahead in line in the capitalization structure.
Manage Your Equity Investments on Eqvista
After reading this you may now be ready to take up some equity investment for your business. But as you do, remember to keep track of all the shares you give out in your company. The way to do this is by using a cap table application like Eqvista.
Eqvista is an advanced cap table application that can help you easily track and manage all your company shares. Add shareholders, issue shares electronically, and manage everything all from one place.