Equity financing is the driving force behind some of the top tech firms operating today. Business owners use this source of funding to get their enterprise through the next growth stage, while investors reap a healthy return. It can benefit all types of businesses, from start-ups through to more established companies, since there’s no interest to repay and the founders can focus on growth.

In this guide, we explore the different types of equity finance, key advantages and pitfalls, how it works and alternatives to consider.

What is equity financing?

Equity financing is a form of funding where companies get capital from investors in exchange for a share of future profits and a level of control in the business. Raising capital by selling shares in your business and striking an agreement with investors means you avoid the burden of debt of traditional finance products, like loans and lines of credit.

When the cost of growth is larger than your budget, equity financing can be a good option. However, be aware that investors receive a share of the company, along with voting rights and a portion of the profits/losses, in return for their funds. 

Equity financing is often used by:

• Start-ups – new businesses needing capital to get up and running, develop products, enter the market and start generating revenue.
• Riskier ventures – those with high-risk, high-reward investment needs, who may not be able to get the funding they need from traditional lenders.
• Established businesses – companies looking to fund their next stage of growth and expansion, such as scaling operations, entering new markets or launching new products.

Businesses using equity financing can secure the capital needed for ambitious growth plans while aligning investor interests with their success. This provides a healthy injection of funds while getting valuable expertise and networks from investors, contributing to the company's overall growth and sustainability.

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What is the difference between equity finance and debt finance?

Debt financing and equity financing are both great ways to help fund your business growth. The main difference is how the lender or investor is compensated for the capital they provide to your business.

Equity finance

With equity finance, you must give up a degree of ownership in your business. In return for their money, the investor will become a shareholder, meaning they’ll enjoy various rights and receive future gains (or losses). For business owners, there’s no commitment to pay back the capital, but it does give the investor a level of control.

Debt finance

Debt financing is based on a promise to repay capital borrowed from business finance lenders. Using a form of commercial business loan or line of credit means you must pay the money back, usually in monthly instalments, including interest. Therefore, you may pay back more than you borrowed, but you don’t dilute your ownership of the business and give up control.

Determining which form of financing is right for your business depends on your financial circumstances, funding needs and growth plans. Not everyone will be eligible for a loan, limiting access to debt financing. Consider start-ups that don’t have a track record and can’t yet prove profitability. This can be deemed too risky for some lenders, but they may have better luck with equity finance, where investors are more willing to take on the risk.‍

How does equity financing work?

While equity financing typically comes from angel investors or venture capitalists, it can also be funding from family, friends or the public. In return for becoming shareholders, investors can provide the funds you need to take your business to its next level. Some investors will be more involved in decisions made in the company.

It’s possible to go through several rounds of equity financing. But remember, anyone who owns more than half of the shares becomes a controlling shareholder.

Example of equity finance

William has started a new business. Up until now, he has invested £100,000 of his own money, so he owns all the company’s shares.

While the start-up is showing a lot of promise, it needs capital to grow. William finds an outside investor – his friend Helen – to supply the funds he needs. Helen agrees to pay £40,000 for 40% of the business' shares. This means that the company has now raised a total of £140,000 in capital, and William now has a 60% stake in his business.

Different types of equity financing

If you’re wondering how to raise equity financing, you need to know the different options available. Here are the main types of equity finance to consider:

Business angels

Angel investors (or business angels) are often wealthy individuals with entrepreneurial experience themselves. They use their personal funds to help businesses in need of capital. They may also bring their knowledge, expertise and industry contacts to the table.

These investors can even be found close to home, with many businesses turning to family members, close friends and professional contacts.

Venture capital

Venture capitalists are employed by venture capital (VC) firms to invest other people’s money into businesses with high revenue potential. They tend to invest larger amounts than business angels, but take on fewer investments.

VC firms may also be looking for a seat on your board of directors.

Initial public offering (IPO)

An IPO is when a business sells shares of its stock to the general public for the first time. This is also referred to as “going public”, as it marks the transition from a privately held company to becoming a public company.

Mezzanine financing

Mezzanine finance blurs the lines between equity finance and debt finance, making it a hybrid financing solution. It’s when a business secures a loan, but the lender can convert this to an equity share after a set timeframe. So, they have an option to gain shares in the company rather than receive the full amount of capital back. In some cases, it can be agreed that some of the money will need to be paid back as equity.

This method is a way to get the funds you need without giving up a large share of your business. You can maintain as much control as possible, for longer.

Private equity

This form of investment is similar to venture capital. Both pool others’ money into companies in the hope of a positive return. However, private equity investors tend to choose more mature and established companies, and are more likely to purchase a larger share of the company (50-100%), looking to improve its profitability.

Corporate venture capital

Large corporate VCs will often invest in smaller firms as part of a wider strategy, which could result in funding for your business in exchange for equity. 

Equity crowdfunding

This type of equity financing seeks to raise a large number of smaller investments to generate capital. You can explore specific crowdfunding platforms that allow you to pitch your product or service to catch investors’ attention. You can promise various rewards, benefits and incentives in exchange for funds.

Family offices

Wealthy families with significant amounts of money will sometimes invest in smaller businesses to generate more income. By contributing cash in exchange for equity, they hope to see their investment grow, as the business does.

Government schemes

National schemes such as the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) encourage investors to put capital into new and growing companies by offering tax relief.

Pros and cons of equity finance

Equity financing tends to suit younger businesses or start-ups, as at this stage, it’s often most beneficial for all parties. Cash flow is usually tighter when you’re first starting out, so an injection of capital within the first few years can go a long way. For the investor, a small percentage of a business during its infancy may well be worth a lot more once it matures.

However, let’s look at the main pros and cons of equity finance to help you judge its suitability for your particular business and its funding needs:

Advantages of equity financing

• There’s no commitment to pay back a set amount, and there’s no interest.
• Investors can bring you more than just money – some can offer their own experience and skills, and may be able to help with business decisions.
• Investors may provide further funding as the business continues to grow.

Disadvantages of equity financing

• Finding the right investors and raising the required finance can take a lot of time and energy.
• You’ll need to be willing to give up some control over your own business – as a shareholder, an investor may want to have a say in key decisions, and they might not always be on the same page as you.
• Selling a cut of your business will also affect your share of the profits, so it’s worth bearing in mind that your reduced share could become worth a lot more if the investment leads to significant business success.
• Shareholders must be kept up to speed with how the business is doing, which can be time-consuming.

Is equity financing right for me?

With so many options available when looking at business finance, it pays to scope out your key funding needs and weigh up various factors (including the pros and cons outlined) to decide what’s right for you. 

Equity finance can look enticing and be useful if your cash flow doesn’t permit ongoing loan repayments. However, consider if you’re happy to relinquish control and give up a percentage of your business and future profits.

Alternatives to equity finance

To help with your decision over what type of funding is suitable for your business, explore these alternatives to equity finance:

• Business loans: You can access sizable sums of money with secured or unsecured loans for short-term funding needs, such as one-off purchases, working capital requirements and covering cash flow gaps, or longer-term needs, such as large-scale expansion plans or property development.
• Lines of credit: Using a business line of credit allows you to draw down funds from an agreed borrowing limit, with the option to top up if demonstrating responsible debt management.
• Asset finance: From hire purchase agreements to finance leases, asset finance lets you spread the cost of high-value assets, such as machinery and vehicles, either owning or returning them at the end of the term.
• Merchant cash advances: This is a type of revenue-based funding that is repaid as a percentage of future card sales, ideal for retailers and online businesses. 

These are all versions of debt finance, meaning you don’t need to give up any ownership, control or future profits to investors. Instead, you make repayments suited to your financial situation.

At iwoca, we provide flexible business loans, designed to meet the needs of SMEs, offering fast access to funds to fuel growth and support cash flow management. Our loans are unsecured, ideal for growing businesses without many assets to use as collateral. You can borrow between £1,000 and £1 million for a matter of days or as long as 60 months with repayments tailored to your needs.

Find out how to apply for a business loan with iwoca. You can get a funding decision within 24 hours, with funds available just hours after approval.